“We expect the US dollar to follow a path of reduced dominance and weaken over the long term,” Nomura said Monday in a report to clients.
The dollar — an important symbol of America’s global standing — remains the primary currency of choice for investors, who use it to trade a wide array of assets around the globe. It’s also the world’s top reserve currency, held in large quantities by governments, central banks and other major financial institutions. Dollar bulls and skeptics alike note that at present, there’s no real alternative.
Yet investors are becoming less sanguine about the dollar’s outlook. Growing debt loads and Trump’s commitment to “America First” policies have added to risks. A diminished role for the United States on the world stage could encourage allies to step up holdings of other top currencies.
This could hurt the dollar’s value in the coming months, though any substantial change in the global currency regime would take decades.
A weak outlook
Those looking to bet against the dollar point to the worsening economic outlook in the United States, where the number of confirmed Covid-19 cases has climbed to nearly 3.4 million.
“The US has reopened too early, as you can see,” Nomura strategist Jordan Rochester said. “The dollar should weaken in the medium term thanks to the Covid response.” He also noted concerns that unemployment will stay elevated, a view shared by some of America’s biggest banks.
The US government is ramping up borrowing to fund massive stimulus programs to prop up the economy. The budget deficit for June surged to $864 billion, the Treasury Department said this week. And it’s coupled with a sizable current account deficit, which means the United States spends more on goods, services and investments abroad than it brings in.
Other developed economies are borrowing way more, too. But in the United States, the government is issuing debt faster than the Federal Reserve is buying it. That means there are more US Treasuries in the market, which hangs over the value of the dollar, Rochester said.
Eye on the euro
This could “represent a major step toward greater fiscal policy coordination in the region and, importantly, a new source of highly-rated euro-denominated debt for global investors,” Goldman Sachs strategist Zach Pandl said in a note to clients last month.
Pandl said that he expects the euro to appreciate gradually against the dollar but a quicker move is in the cards. “Recent news on the euro area has cut in a clearly positive direction,” he wrote.
The United States boasts a long list of blue-chip companies that are unlikely to fall out of favor. But European assets are getting a closer look as conditions in the region improve, which could drive demand for the region’s currency.
A Bank of America survey of fund managers released Tuesday found a “big jump” in European stock holdings. More than 40% of those surveyed said they wanted more exposure to the euro.
Few alternatives, for now
There are reasons to be cautious. The decline of the US dollar has been predicted on many occasions, and it’s always been premature.
The dollar benefits from being the currency of choice for many global transactions, including the trading of commodities like oil. It accounts for 62% of the world’s currency reserves and is involved in 88% of all global currency trades. That’s unlikely to change drastically in the near or medium term.
“I don’t think we are at the point where the dollar will lose its attraction,” said Jane Foley, head of currency strategy at Rabobank.
She noted that because the dollar tends to strengthen when the global outlook deteriorates, problems in the United States, the world’s largest economy, could actually feed demand for the currency.
But over time, US debt concerns, a weak economy and greater cohesion in Europe could start to undermine the currency, Nomura said. The bank says the dollar could lose up to 20% of its value over the next five years.
The trend may be exacerbated by geopolitics. If Trump wins a second term, Nomura thinks an ongoing push toward deglobalization could undermine the US dollar and encourage greater use of China’s yuan, or renminbi, to settle trades.
Huge regulatory barriers remain due to concerns about fraud and financial crime. But Nomura said it’s especially focused on efforts in China, where the desire to increase global use of the renminbi is strong.