Greenback gloom

The US has found itself under increased scrutiny this year, with markets questioning whether it deserves to be on a pedestal.

Its success has been built on foundations of free enterprise and trade, the rule of law and strong immigration.

Those pillars have been supported by the traditional safety of US Treasury bonds, independent monetary policy and the reserve currency status of the US dollar.

All of this has given America the privilege of borrowing money at very attractive levels.

Current policy settings threaten this exceptionalism, and investors are becoming much less enthusiastic about funding the growing twin deficits of the world’s biggest economy.

We’ve seen a big change in the perception of US assets, which has been reflected in falling growth expectations, a more volatile sharemarket and higher interest rates.

However, currency markets are where all these things intersect and the most telling signs might have come from the US dollar.

It slumped more than ten per cent in the wake of the US tariff proposals in early April, and while the S&P 500 has bounced back since then, the greenback has stayed down.

The US dollar tends to move in long cycles, and the recent moves beg the question of whether we’ve reached another important turning point in its fortunes.

After falling through the 1970s it started rebounding in 1980 when Federal Reserve Chair Paul Volcker raised interest rates sharply to combat inflation.

It hit a record high in 1985, until the Plaza Accord saw several major economies agree to foreign exchange interventions to lower its value.

That led to a US dollar bear market for ten years, until the Fed began raising interest rates in the mid-1990s which saw it rebound again.

That bull run lasted until the dotcom bubble burst in the early 2000s, and the US dollar then languished until 2011 when the European debt crisis seemed to spark a revival.

It’s difficult to say whether another turning point has been reached, but few would deny the events of early 2025 have been significant.

Not only have we seen proposals for the biggest change to US trade policy in 100 years, but markets are scrutinising US borrowing levels more closely.

At the same time, Europe has announced what is arguably the largest shift in European defence and fiscal policy since World War II.

From here in New Zealand, the diverging fortunes are obvious to see.

The S&P 500 in the US has recovered most of its losses and is now close to flat this year.

However, the US dollar has fallen more than six per cent against the NZ dollar, so local investors are still down after those currency moves are accounted for.

In contrast, European shares are up more than eight per cent while the euro has appreciated against the Kiwi, boosting these gains further.

The US dollar has been the world’s reserve currency for 80 years, having started to displace the British pound in the 1920s and secured the undisputed mantle after World War II.

Even so, its dominance has declined in recent decades.

The US dollar share of global currency reserves fell to 58 per cent at the end of last year, the lowest in almost three decades and down from 72 per cent in 2001.

While its reserve currency status is unlikely to come under threat in the foreseeable future, it might have to increasingly share the limelight with others.

The US economy is in good shape, but policy changes could create headwinds at a time when the Fed has limited room to provide support.

At the same time, the greenback is out of favour and US stocks remain more expensive than their international counterparts.

A complete exodus is unlikely, but a partial unwind of US asset ownership is underway as investors diversify into other markets, especially after the great run of recent years.

These asset allocation shifts can take time to unfold, which suggests non-US assets may continue to outperform for a while longer.

The US is the world’s biggest economy and sharemarket, as well as being home to many of the world’s greatest companies.

However, against an increasingly multipolar backdrop some diversification away from the US is prudent, if not essential.

Market Insights enewsletter

Keep up to date with our fortnightly Market Insights enewsletter. Our research team provide timely and regular commentary and analysis on market developments, understanding investment jargon, and the impact of current events.

Subscribe Now