Since the pause of US President Donald Trump’s Liberation Day tariffs on April 8, the S&P 500 is up more than 20%. However, the US dollar is making new lows for the cycle.
Despite signs of economic resilience, JP Morgan Private Bank’s global market strategist Julia Wang continues to expect further declines in the US dollar.
Long-term valuation models suggest the US dollar is still between 5%-15% overvalued compared to major peers like the euro and Japanese yen.
Wang lists three pillars supporting her US dollar house view:
Global asset re-allocation
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The US runs the largest trade deficit in the world of around US$1 trillion ($1.28 trillion) annually, meaning it requires roughly that amount in other types of inflows to offset depreciation pressure on the US dollar.
Foreign inflows to US capital markets over the past three months are consistent with an annualised pace of just US$100 billion, and lower than foreign inflows to ex-US markets.
Increasing FX-hedge ratios
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Recent years of persistent US dollar strength and negative correlation between the greenback and risk assets saw foreign investors reduce the degree to which they FX-hedged their holdings of US assets, says Wang.
Those prior trends are now in question, she adds, and the longer they are in doubt, the more foreign investors are likely to increase the degree to which they FX-hedge their US dollar asset holdings.
“We are already seeing some of the quicker-moving institutional funds in Europe take action; the Danish pension fund and insurance industry, for example, has increased its US dollar hedge ratio by 12 percentage points year to date, back to near the highest levels seen over the past 10 years,” says Wang.
Cyclical convergence
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Historically, the US dollar’s performance has been highly correlated with the difference in interest rates between the US and the rest of the world, says Wang. “That relationship has been less stable since April as the asset allocation and FX-hedging decisions of global investors have become more important drivers.”
However, US yields have resumed their convergence toward those of major peers in recent weeks, providing another impetus to drive the US dollar lower.
Bottom line
Even as the US dollar makes new lows for the cycle, it remains 5%-15% overvalued on long-term valuation metrics, notes Wang.
“Less dominant US cyclical outperformance versus [the] rest of [of] world, ongoing signs of a slowdown in foreign investor allocations to US assets and an increase in FX hedging activity underpin our expectation for further US dollar weakness against its major peers,” says Wang.
Wang and her team continue to recommend international diversification for US investors and “appropriate” management of long US dollar exposure for those outside of the US.
Charts: JP Morgan Private Bank
