Markets: Dollar Volatility Begins
The dollar shows first signs of doubt
Dollar Volatility Begins
As the Trump administration’s economic policy has unfolded over the past month, full of sound and fury, I’ve kept my eyes open for one specific signal, a key indicator which was absent. Until yesterday. Amidst the uncertainty of rising tariffs, inflation, general instability and economic warfare, there were the first hints of doubt in the dollar’s status as a safe-haven asset.
The reasons for this are reasonably straightforward. The US has historically been a stabilizing force in global markets - as such, in times of economic turmoil, investors tend to flee to the dollar as the ultimate risk-off asset. Yet, as the US increasingly becomes a driver of geopolitical risk as opposed to a mitigator of it, that calculus is starting to shift. Investors have reason to wonder whether the dollar itself may be subject to instability as a result of US policy. This week’s developments are a case in point: rather than strengthening in response to volatility, rising instability was met with a declining dollar, with currencies like the euro and the peso performing favorably by comparison.
Source: Trading Economics. It’s not looking great.
Any threat to the dollar as the central currency of global trade is an existential threat to the US economy itself. The structural privileges it affords - cheap financing of debt, an automatic value stabilization mechanism for value due to global demand, and immense influence in international transactions - form the foundation on which the current American financial ecosystem is built. Without the dollar’s ubiquity as a safe haven asset, US federal debt would require immediate stabilization via increased taxation of an already over-leveraged American consumer base (something we’ve discussed before) or a series of very embarrassing conversations with the IMF.
Yet, for now, de-dollarization fears are likely overblown. The signals we’re seeing are primarily a matter of short-term volatility. This article, which highlights the fears investors are currently expressing, also serves to illustrate just how important the dollar is in the global economic landscape: to question its survivability is to question the survival of globalization itself, in their views. Because extraordinary claims require extraordinary proof, it is likely that investors will alight upon any signal of stabilization in order to allay their fears and stay the current course. This is undoubtedly why Secretary of Commerce Howard Lutnick was doing the rounds in the financial press today to explain that the trade war with Mexico and Canada would likely be short-lived.
It’s also worth noting that the dollar remains near historic highs, and has performed well against other currencies since the pandemic. It remains the backbone of international trade, and all other competitors either lack the depth, liquidity, and geopolitical neutrality necessary to upstage it. Central banks still hold the dollar at rates vastly exceeding any other currency (for now), and investor diversification this week has largely benefited gold.
That being said, there is a limit to how many shocks the system can absorb before credibility starts to erode. The dollar’s dominance is a matter of inertia and collective belief - a belief that, if shaken too frequently, could force investors and nations to seek alternatives, however imperfect. And given the administration’s tone, I suspect this roller-coaster ride is only just beginning.
Atlas’s knees are starting to buckle.
Shane McLorrain
Research Lead