Representative image of US dollar.
Credit: iStock Photo
The dollar is off to its worst start to a year in more than half a century.
The United States’ currency has weakened more than 10 per cent over the past six months when compared with a basket of currencies from the country’s major trading partners. The last time the dollar weakened so much at the start of the year was 1973, after the United States had made a seismic shift that had ended linking the dollar to the price of gold.
This time the seismic event is President Donald Trump’s efforts to remake the world order with an aggressive tariff push and a more isolationist foreign policy.
The combination of Trump’s trade proposals, inflation worries and rising government debt has weighed on the dollar, which has also been buffeted by slowly sliding confidence in the role of the United States at the center of the global financial system.
That means it is more expensive for Americans to travel abroad and less attractive for foreigners to invest in the United States, sapping demand when the government is trying to borrow more money. On the flip side, the weaker dollar should help US exporters and make imports more expensive, though these typical trade effects are in flux because of tariff threats.
Even as Trump has backed down from his most extreme tariffs and the US stock and bond markets have recovered from their losses earlier in the year, the dollar has continued to slide.
“Having a weak dollar or a strong dollar isn’t the issue,” said Steve Englander, global head of G10 foreign exchange research at Standard Chartered. “The issue is: What is it telling you about how the world sees your policies?”
Initially, the dollar soared on Trump’s reelection. Much like investors in the stock market, currency players perceived him to be pro-growth and pro-business, likely drawing in investments from around the world and raising demand for US currency.
Such enthusiasm did not last. After peaking in mid-January, the dollar index began to slide. Hopes of a pro-business administration gave way to lingering worries about stubborn inflation and the impact of high interest rates on the economy and on companies in the stock market.
Then came Trump’s unexpected announcement of tariffs that were far, far higher than any economist, investor or analyst had predicted, sending markets — from stocks to bonds to the dollar — into a panic.
Investors worried that the inflationary impact from tariffs could keep interest rates elevated for longer, turning the screws on an economy that was beginning to show some signs of weakness.
As the administration initially doubled down on tariffs, economic concerns intensified into worries about the safety of US assets at a time of upheaval in global trade. What had begun as anxiety about inflation and the labor market became more acutely centered on the drastic effect that Trump’s tariffs could have on the entire financial system.
Analysts fretted about a broad shift away from the dollar and US assets more broadly — a change from recent years, when the United States dominated the investment landscape and money poured into American assets. Notably, even after such a weak start to the year, the dollar isn’t that weak historically, because it started from such a high level.
“I think there is a concern that the US that looked exceptional is falling into the pack,” Englander said.
Higher tariffs most likely mean lower imports, and lower imports mean fewer dollars paid to businesses overseas. That, in turn, could reduce the dollars reinvested back into the United States, in markets such as government bonds, both because of the simplicity of avoiding exchanging currencies and because of the confidence investors have in US markets.
The impacts of the dollar’s recent decline are far-reaching. The last time the dollar began a year with such a steep decline was in 1973 when foreign currencies stopped being linked to the dollar. That move came two years after President Richard Nixon decided to no longer link gold to the dollar.
For some, this year’s weaker dollar has cut into returns from the once again booming US stock markets. The S&P 500 hit a record high last week, having rallied 24 per cent since the administration backed down on much of its initial tariff plan.
But converting the return of the S&P 500 from dollars into euros makes the rally look a lot different, up only 15 per cent and still 10 per cent away from an all-time high.
For American investors, the weaker dollar can encourage looking outside the United States. The Stoxx 600 index, a broad measure across European stocks, has risen roughly 15 per cent over the same period, but converted back into dollars that gain rises to 23 per cent. Already, pension funds and endowments, among other investors, have said they are looking more closely at markets outside the United States as a result.
Waning demand for US assets stemming from tariffs has also collided with the government’s plans to increase spending, dashing hopes among some fiscal hawks that Trump would follow through on his campaign promise of decreasing government spending.
Despite opposition in the Senate, an economic and domestic policy bill has begun to make its way back through Congress and is estimated to add trillions of dollars to the deficit over a decade.
The government would make up this shortfall by looking to borrow more from investors in the Treasury market, precisely when those same investors have begun to back away, raising concerns about the stability of the market.
Such concerns undercut the role of both Treasuries and the dollar as a haven in periods of stress.
Typically when investors are worried, they seek out assets that they are confident will hold value during periods of turmoil. But worries about the dollar have weakened it further even during volatile trading conditions, suggesting that it is not consistently playing the same haven role for investors at the moment.
“Full-scale de-dollarization, if it ever comes, is still a long way away,” said Rick Rieder, chief investment officer of global fixed income at BlackRock, in the fund manager’s latest quarterly outlook. “But there is one dynamic playing out that could significantly raise that risk: increasing government debt.”