Investors betting on the dollar’s continued dominance in the years to come are overlooking the risks of rising political instability in the US and escalating tensions with China.
(Bloomberg) — Investors betting on the dollar’s continued dominance in the years to come are overlooking the risks of rising political instability in the US and escalating tensions with China.
That’s the thinking of JPMorgan strategists who argue that the markets aren’t fully reflecting the risk of a “rapid and deep” decline in the greenback’s status as the currency of choice for global reserves and trade — a process known as dedollarization. It’s also left the dollar expensive on a historical basis.
“If US-China tensions intensify and we get more global fragmentation, it would likely lead to de-globalization in trade and finance,” said the strategists including Jan Loeys and Joyce Chang. “In finance, it could also lead to dedollarization.”
Chief among the factors that could threaten the dollar’s long-term dominance is political dysfunction in the US that could block efforts to manage the national debt, “preventing a government from stabilizing the economy during a crisis due to fiscal constraints,” the strategists wrote in a report released Tuesday.
Earlier this year, political brinkmanship threatened the world’s largest economy as politicians sparred over debt ceiling limits before reaching a last minute resolution. It’s a phenomena that could become more common amid an increasingly divided country.
Another risk scenario the strategists outline is an intensifying competition between the US and China, which they say could become “Cold War 2.0.” Within China, a laundry list of economic reforms — from easing capital constraints to promoting market liquidity — would also threaten the dollar’s supremacy, they added.
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According to JPMorgan, the impact of a move away from the dollar and shocks to its stability would be felt broadly across asset classes, bringing down the value of the greenback and equity multiples while boosting bond yields.
Meanwhile, the US currency is trading near historical highs on an inflation-adjusted basis through May, according to the latest data from the Bank of International settlements. Notably, the data does not include July’s sharp dollar selloff, which saw a Bloomberg gauge of the greenback fall nearly 2% last week to April 2022 lows.
The odds of the dollar being supplanted altogether as the key reserve currency within the next 10 years are quite low, the strategists said. They see a “partial dedollarization” as more likely, with China — as the largest competitor to the US and the dollar in the global economy — taking on more and more of the greenback’s role among non-US aligned nations.
While still the dominant reserve currency, the dollar’s share of international reserves fell from 73% in 2001 to 58% in 2022, as measured by International Monetary Fund data. However, the greenback’s allocation in sovereign wealth fund portfolios has offset that decline.
For investors concerned about the greenback losing ground as well as diminishing interdependence across national borders, JPMorgan recommends being underweight the dollar, US markets, financial stocks, and long-duration bonds in their portfolios. The bank also recommended betting on value-oriented US stocks, which tend to “outperform growth in a rising real yield environment.”
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