Global Markets Hit New Highs, but the Dollar Ends Weakly
As the Iran-Israel conflict cools and market optimism grows about U.S. trade negotiations, global stock markets have hit historic highs at the end of the second quarter. However, the dollar has plummeted against this trend. The dollar index fell below the 97 mark on the last trading day of the second quarter, with a cumulative drop of 10.7% in the first half of the year, marking the worst start since the era of floating exchange rates began in 1973.
On Monday's late trading, the dollar index broke below the 97 mark, hitting its lowest level since March 2022. Bank of America believes that the trend of "de-dollarization" continues, with global investors losing trust in U.S. assets and consistently reducing their dollar exposure.
Speculative Dollar Short Positions Reach Recent Highs
According to the U.S. Commodity Futures Trading Commission (CFTC), speculative dollar short positions reached their highest level since July 2023 as of the week ending June 24. Wall Street strategists pointed out that one reason for the dollar's astonishing decline this year is Trump's reshaping of the global trade order with tariffs, prompting investors to rethink the dollar's role in global investment portfolios.
A June survey by Bank of America of 190 institutions showed that after President Trump threatened to raise tariffs again in April, institutional investors avoided U.S. assets, and pessimism towards the dollar reached a 20-year high. This reflects concerns about U.S. macroeconomic risks and declining competitiveness.
De-dollarization and Accelerating Capital Outflows Impact
Vassallo, a portfolio manager at BNP Paribas Asset Management, noted that the dollar is entering a "long-term downtrend." Even though the worst scenario regarding tariffs has eased, U.S. policy instability and a tough foreign stance have raised widespread concerns. Data shows that Danish pension funds have reduced their dollar exposure by $37 billion this year, and large global institutions are steadily adjusting the weight of the dollar in their asset portfolios.
If the U.S. enacts Section 899, imposing "retaliatory taxes" on foreign investors, it may further weaken capital inflows and put more pressure on the dollar. Englund, head of FX at Standard Chartered Bank, said such tax hikes would directly impact the capital support for the dollar.
Fed's Rate Cut Expectations Continue to Pressure the Dollar
Recently, Fed governors Waller and Bowman have indicated possible rate cuts in July, and the market is closely watching the upcoming June non-farm payroll report to determine if a cut will be formalized this month. Renaissance Macro economist Dutta stated that the U.S. labor market is weakening, with unemployment claims at cycle highs, indicating an increase in permanent layoffs, reminding the Fed that "the train has already left the station" and that policy remains too tight.
Loh, a senior strategist at State Street Bank, believes that unless there is a significant shift in Trump administration policy, the dollar may experience a long-term weak cycle similar to the euro's rise from 2002 to 2008, asserting that "the dollar definitely has room to fall."
How Should Investors Deal with Long-term Dollar Weakness?
If the dollar continues its downward trajectory, global asset allocations might accelerate towards non-U.S. assets. Data shows that over 54% of institutional investors believe that non-U.S. stocks will deliver the best returns over the next five years, with only 23% favoring U.S. stocks, and gold ranks third, indicating a continued demand for safe-haven assets.
At the same time, if the U.S. stock market unexpectedly surges, it could temporarily rescue the dollar and make it attractive to capital again. Vassallo noted, "If U.S. assets outperform significantly again, the dollar might temporarily gain support, but the overall long-term weakness trend is difficult to reverse."
