US Dollar: is the tide going out?

Peter Warburton - 15 February 2018

There is a debate raging over the characterisation of the US Dollar: is it a defensive currency that performs better in a risk-off environment or has it entered a structurally weak phase that may stretch over a number of years? My inclination is towards the latter. I suspect that the high tide for international – especially Asian – participation in US securities markets has passed (figure 1). This conviction is strengthened by the observation that, post-GFC, the US Dollar has performed badly when US CPI inflation is rising and vice-versa (see figure 2).

Figures 3 and 4 give clear indications that the overseas appetite for US Treasury securities is waning. This reflects both the preferences of the official sector (including sovereign wealth funds) in terms of the management of their foreign currency reserves and overseas wealth, but also the asset allocation decisions of private sector wealth managers.

Figure 3 also shows that the foreign ownership share of US agency and GSE debt peaked before the global financial crisis. For security repos, the post-crisis rebound in the density of overseas ownership is waning.  There has been some softening in the foreign share of corporate equities, but it is very slight. The countervailing, positive, trends are for commercial paper and corporate and foreign bonds. In so far as the latter is the most blatant example of the global ‘search for yield’ phenomenon and risk premiums look very compressed (see figure 5, pinched from Alex Brazier’s recent speech) then it is conceivable that, in a spread widening scenario, foreigners would quickly become net sellers of this asset class also. 

The justification for decreased overseas participation in US security markets presumably reflects strategic considerations linked to geopolitics and de-globalisation as well as the calculus of expected short-term returns. Critically, foreigners own roughly 4 times as many US debt securities as US residents own of foreign debt securities. This asymmetry is a risk factor for the US Dollar as inflation complacency recedes.

A fundamental reconsideration of the role of the US Dollar could undermine its traditional role as a protective international asset in volatile markets. The installation of a new chairman at the helm of the US Federal Reserve, whose views on many important topics are undisclosed, and flaky comments from the US Treasury Secretary at Davos have not aided the Dollar’s cause.


Figure 1

Data source: US Federal Reserve, Z1

Figure 2

Data source: Thomson Reuters Datastream​​​​​​​

Figure 3

Data source: US Federal Reserve, Z1​​​​​​​

Figure 4


Figure 5

Source: Bank of England​​​​​​​



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