"Selling America" transaction headline, road to falling US dollar may be long

The uncertainty surrounding trade, the escalating government debt, and the weakening faith in American exceptionalism have put pressure on US assets, with the US dollar being one of the victims. As the dollar falls from its overvalued position, investors believe it will continue to lose its charm. The Trump administration's tariff aggressions this year have prompted investors to reduce exposure to US assets, despite their strong long-term performance. Although the dollar has stabilized in recent trading days due to optimism regarding a US-China trade war ceasefire, Moody's downgrade of the US sovereign credit rating has once again put pressure on the dollar. George Vessey, Chief FX and Macro Strategist at payment company Convera, said, "From a valuation standpoint alone, the dollar still has significant room for further depreciation." He mentioned that after Moody's downgraded the US credit rating, "selling US assets" has once again become a focus. The US dollar index has dropped 10.6% from its January high, marking one of the largest declines in three months. Data from the US Commodity Futures Trading Commission (CFTC) shows that speculative USD short positions have reached $17.32 billion, close to the largest short position since July 2023. Part of the bearish sentiment towards the dollar stems from its relatively high valuation - the dollar index in January was 22% above its 20-year average level of 90.1. Currently, the index is around 10% above the 20-year average level. There is still significant potential for further depreciation of the dollar, with a 10% drop potentially reaching the low point seen in President Donald Trump's first term. Warning signs of a massive deficit For years, investors and strategists have believed the dollar to be overvalued, but with the strong growth of the US economy, shorting the dollar has proven to be a painful trade. This situation may be about to change. Steve Englander, Global Head of G10 FX Research at Standard Chartered Bank in New York, said that while recent trade arrangements may partially soothe the markets, they do not address the long-term confidence issues facing the US. "The story of the weak dollar is not over yet," Englander said. Investors are also concerned about the long-term fiscal situation in the US. Analysts suggest that Trump's comprehensive tax cuts could increase the US's $36.2 trillion debt by $3 trillion to $5 trillion over the next decade. George Saravelos, Global Head of FX Research at Deutsche Bank, said, "The waning interest in purchasing US assets, combined with the stagnant US fiscal process leading to persistently high deficits, has made the markets very nervous." The Trump administration has maintained its support for a strong dollar policy. White House spokesman Kush Desai said, "President Trump has made it clear that he wants to maintain the strong influence and power of the dollar as the world's reserve currency." Foreign selling of US assets Despite recent foreign selling of US assets, years of appreciation in US assets mean that trillions of dollars in US stocks and Treasury bonds are still held globally. Investors suggest that this selling pressure may come from all corners of the globe, as more people are concerned about the dollar's recent failure to serve as a safe-haven asset. Peter Vassallo, FX Portfolio Manager at BNP Paribas Asset Management, said, "It's really shocking... If the dollar is no longer a safe-haven currency, does it still make sense for us to hold so many dollars in our portfolio?" However, Colin Graham, Head of Multi-Asset Strategies at Robeco, stated that while people are looking to reduce risk and rebalance their portfolios, "it has not evolved into people selling dollars, assets, stocks, or US Treasury bonds to repatriate funds." He noted that this scenario is still possible. Selling the dollar on rallies? The past decade of dollar strength has led market participants to hold US assets without too much worry about exchange rate risks. According to estimates from banks like Deutsche Bank, the high level of foreign-held US assets, valued in the trillions of dollars, could trigger massive sell-offs even with a small increase in the hedging ratio (the proportion of protected foreign exchange risk exposure). Increased hedging by investors means reduced direct demand for the dollar, leading to increased selling pressure in the forward markets. After investing huge trade surpluses in US assets for decades, Asian economies including China, Korea, and Singapore have accumulated massive dollar exposures. In a report in early May, Stephen Jen and Joana Freire of Eurizon SLJ Capital stated that Asian exporters and institutional investors have hoarded around $2.5 trillion, presenting significant downside risks to the dollar against these Asian currencies. However, contrary to the bearish dollar narrative is the resilience of the US economy. If economic growth unexpectedly picks up, the Federal Reserve may remain on hold for longer, supporting the dollar. Jack McIntyre, Portfolio Manager at Brandywine Global, pointed out that US consumers have remained resilient so far. However, he and others are more inclined to sell the dollar on rallies rather than bet on a dollar rebound. McIntyre said, "The current situation seems more like looking for opportunities to sell the dollar on rallies."