Dan Mitchell, Senior Portfolio Manager, RBC Global Asset Management Inc., discusses how the recent shift in sentiment and economic factors will impact the U.S. dollar and global currency markets.
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How will the recent shifts in sentiment and economic factors impact the U.S. dollar and global currency markets?
There are some big changes happening in the foreign exchange markets, and they're really worth paying attention to. The biggest and the most important development is the shift in sentiment against the U.S. dollar. Now, at the beginning of the year, the greenback was in high demand owing to its stronger economic growth, higher interest rates, better equity returns. But there was also this universal belief that Trump's tariffs would be positive for the dollar.
That dollar demand has really withered, though, and since Trump's inauguration, the currency has declined by about 10% on a trade weighted basis, going from much love to most hated in the currency world. The decline isn't really from any one factor in particular, but stems from a bunch of things all coming together at once. First, the perspective on tariffs has flipped to dollar negative and is now seen as taking a bigger toll on the U.S. economy than on others.
Erratic decision making from the white House has also amplified that, with associated economic uncertainty, holding back business and household spending. Second, there's new questions being raised about some of Trump's other policies toward isolationism and withdrawal from global institutions, not just the World Trade Organization, but also from health, military and climate cooperation. The reaction from Germany and Canada and others has been to increase spending on defense, which could boost economic growth abroad and pull capital away from the United States.
Third, the dollar seems to have given up its safe haven qualities, which means global investors can no longer rely on it to protect returns when stock markets fall. In early April, those investors experienced a double hit from falling stocks and a weaker dollar, which caused them to question those large holdings in U.S. assets. And then, of course, there's those longer term structural issues that we'd flagged in past videos.
The dollar's significant overvaluation, some anxiety about rising debt levels and excessive fiscal spending, and a gradual shift toward using other currencies for global trade and investment. So even though the dollar has already fallen by 10%, we think the U.S. dollar decline has much further to run. The gradual shift out of U.S. dollars is likely to play out over several years, and will likely be universally positive for most developed and emerging market currencies.