Dollar Set to Plummet as U.S. Debt Crisis Looms
Dollar Demise Looms as Investors Flee U.S. Assets Amid Growing Concerns Over Trump’s Tariffs and Federal Debt
The dollar is facing a significant decline in coming months, with a near-90% majority of FX strategists polled by Reuters predicting a decrease in demand for dollar-denominated assets. This trend is largely driven by concerns over the U.S. federal deficit and debt, which have soared to an enormous $36.2 trillion after the House of Representatives recently passed a tax-cut and spending bill that would add another $3.3 trillion.
The usually close relationship between the dollar and 10-year Treasury yields has broken down, with long-term bond yields soaring due to a rising ‘term premium’ – compensation for holding longer-duration debt. This increase in term premiums has led to significant asset outflows, causing a near-10% fall in the dollar against a basket of major currencies since mid-January.
The ‘sell-America’ trade is gaining momentum, with many investors worried about the impact of President Trump’s erratic tariff policies on U.S. growth. Jane Foley, head of FX strategy at Rabobank, noted that "it’s quite evident right now there is a ‘sell-America’ trade playing out, and how much dollar demand decreases depends on the extent to which U.S. growth is perceived to be hit by the current policies of the administration."
If the market continues to anticipate a negative impact on U.S. growth, the trend will likely continue towards further dollar losses over the medium-term. Over 55% of analysts polled expressed concern about the dollar’s ‘safe haven’ status, up from around one-third in April. This month, more than half of respondents upgraded their euro forecasts, with the common currency predicted to hold steady at $1.14, gain about 1% to $1.15 in six months, and rise by a further 3% to $1.18 in a year.
The euro-dollar median forecasts recorded in the survey are the highest since November 2021, with only around one-third expecting the euro to reach parity within a year just a few months ago. However, most of this shift is due to the outlook for the dollar rather than an increase in investor confidence in the euro.
A series of interest rate cuts by the European Central Bank while the Federal Reserve has stayed on hold would normally lead to a different outcome on interest rate differentials. However, the ECB’s actions are expected to be insufficient to counterbalance the negative impact of U.S. fiscal concerns and hard labor market data starting to turn, which is a very negative combination for the dollar.
Dan Tobon, head of G10 FX strategy at Citi, noted that "over the summer, we’re expecting (U.S.) term premium risks on elevated fiscal concerns and hard labor market data starting to turn. That is a very negative combination for the dollar." Their target for euro-dollar has been $1.15, but they think it can get to $1.20. This could happen sooner than expected if these catalysts do play out.
Speculators’ Net-Short Position Unlikely to Change
The thinning dollar trade is unlikely to evolve significantly by end-June, with half of the strategists polled saying there would not be much change from speculators’ current net-short position. Nineteen respondents said that there would be an increase in net-shorts, while two predicted a decrease.
Europe to Benefit Most from Dollar Outflows
The region expected to benefit the most from sustained dollar outflows is Europe. Despite a slight souring of sentiment owing to the Trump-led trade war, investors remain generally optimistic about infrastructure and defence spending plans, particularly in Germany, which will revitalise the bloc’s long-sluggish economy.
Citi’s Tobon noted that "when you talk to clients in the European area, they feel like there’s a lot more potential positive catalysts for growth there – not just because of the money that will be spent on defence and infrastructure – but because there’s belief that’s actually the beginning of a lot of other structural changes."
Heightened Uncertainty Ties Fed’s Hands
Heightened uncertainty from rising U.S. inflation expectations – near their highest in at least four decades – has effectively tied the Fed’s hands for the time being, even though markets still expect two more cuts this year. The ECB is expected to cut interest rates this week and possibly once more.
Conclusion
The dollar is facing a significant decline in coming months due to concerns over U.S. federal debt and Trump’s erratic tariff policies. A near-90% majority of FX strategists polled by Reuters predict a decrease in demand for dollar-denominated assets, with the euro expected to benefit from sustained dollar outflows. The region that will benefit the most is Europe, where investors remain optimistic about infrastructure and defence spending plans. Heightened uncertainty from rising U.S. inflation expectations has effectively tied the Fed’s hands for the time being, limiting their ability to respond to the current economic situation.
