The dollar slide - more than an adjustment?

 

The dollar is overvalued. It has been overvalued for years, and the size of the overvaluation going into 2025 was extreme, similar to the mid-1980s when the Plaza Accord was implemented. There is a clear reassessment of the dollar, despite many foreign investors still being interested in holding US assets. Investors are now willing to hedge their dollar exposure. A policy of lower interest rates, coupled with expectations of inflation above the 2% target, and slower growth expected in 2026, all contribute to a lower dollar mentality.

That said, there is no dollar substitute, as measured by the use of the dollar in trading and cross-border finance. The adjustment in dollar usage will be slower than any market change in the dollar, so it may be too early to make judgments on dollar usage; yet, current measures of dollar internationalization have remained within normal bounds. A switch to the EUR is unlikely given their economic malaise. The natural switch will be to China, yet the CNY is not a liquid or easily convertible currency. There is more pricing in CNY and factor financing in CNY, but it is not being accepted as a store of value. 

While the dollar move is much larger and faster than we have expected, the current move is a natural adjustment that takes us back to a long-term average. Dollar selling should continue. There is no reason to expect a reversal. This adjustment should not be concerning, even though the geopolitical language of today is abnormal.