Dan Mitchell discusses the key drivers behind the U.S. dollar's decline, including softer employment numbers, Fed rate cut expectations, and concerns over inflation. He also covers the implications for global currencies such as the euro, yen, pound, and emerging market currencies. Soo Boo Cheah offers insights into the sovereign bond market, highlighting the income potential of government bonds, the steepening yield curve, and the factors influencing long-term bond yields.
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What are the key drivers of the U.S. dollar's decline and its implications for global currencies?
Dan Mitchell
The big debate for us and currency markets still surrounds the fate of the U.S. dollar and that matters because when the dollar falls like it has this year, every other global currency tends to rally. This early stage in the U.S. dollar’s bear market, traders are less focused on country-specific factors and instead are paying a lot more attention to the broad movements of the greenback.
That's what's going to drive the majority of currency returns over the next few years. To date, the dollar's down about 10% in 2025. It fell in each of the first six months of this year and declined against most emerging and developed market currencies. It took a short pause in July before resuming its decline. And then the main factors pushing it lower this time are softer employment numbers, rising expectations that the Federal Reserve could cut rates a couple of times this year, and an increasing sense that the U.S. central bank is losing its independence as the White House attempts to strongarm the Fed into easing monetary policy. Bond and currency investors have become increasingly nervous about structurally high inflation that would reduce the dollar's purchasing power. And that's why longer-term bond yields are rising, even as the Fed is about to cut rates.
Basically, investors demand a higher return now to compensate for that risk of inflation. And it's also why gold prices are rallying. Looking forward we think the euro, the yen and the pound will continue to benefit from a falling dollar as the central bank credibility theme unfolds. The Canadian dollar will strengthen too. But let's not forget that those currencies have already rallied a bunch.
And they also have their own issues. Political dysfunction in France, budget issues in the UK and some trade uncertainty in Canada with renegotiations with the U.S. set to take place next year. We suspect that emerging market currencies may be the ones that deliver a better performance as the greenback weakens next year. And so we think that investors would be wise to consider hedging the U.S. dollar exposures in their portfolios.
And we also think it's worth diversifying into a broader set of currencies that might outperform the loonie. As this next phase of U.S. dollar weakness begins.
What is your outlook for the sovereign bond market?
Soo Boo Cheah
We believe government segment is now offering a compelling income potential. In the market now, investors are waiting for the U.S. Federal Reserve to restart its cutting cycle given signs of a weakening labour market. The first cut is expected in September. But here's a twist, this has already been priced into the bond market.
If you look back, since the Trump election, short-maturity bond yields have fallen while long-maturity bonds remained elevated. If you look closer, long-term policy rate expectations have been remarkably stable, at around 4% over the past two years. This stability suggests that investors have been pricing for a new economic reality post-pandemic. That being said, the yield curve has steepened significantly this year.
Investors are demanding a high-risk premium to hold long maturity bonds, in part due to high debt loads or perhaps erosion of Fed independence. These are likely to keep the yield curve steep even when rate cuts arrive. Now let's put all this together. Considering the stable long-run policy rate expectations, high real yields and a steep yield curve, we believe investors are receiving generous compensation for the risk of holding Treasuries. In short, government bonds are providing decent income with a capital gain potential. We believe government bonds investment should outperform cash.