Despite a significant -9% depreciation since January, the U.S. dollar appears poised for further downside. While short-term technical signals may hint at a tactical bounce, deeper structural imbalances suggest the longer-term path remains lower. Historical overvaluation, shifting global portfolios, and weakening U.S. growth prospects all conspire against a sustained dollar recovery.
The overvaluation legacy
Historical context offers a sobering lens. According to Federal Reserve data, the dollar remains nearly two standard deviations above its real effective exchange rate average since 1973. Only two other periods—mid-1980s and early 2000s—saw similar excesses. In both cases, the dollar subsequently fell by 25–30%. The current setup, while not a crystal ball, bears unmistakable resemblance.
Portfolio rebalancing: the quiet giant
The scale of global exposure to U.S. assets is striking. IMF estimates place non-U.S. holdings at $22 trillion—nearly one-third of total foreign portfolios, with half concentrated in equities, often unhedged. Even modest rebalancing could exert downward pressure on the dollar. Swiss data on hedging flows already offer circumstantial evidence: FX flows play a pivotal role in shaping currency trajectories.
Structural current account constraints
A $1.1 trillion U.S. current account deficit demands equivalent capital inflows. While this can be financed via foreign direct investment or asset sales, the bulk historically arrives via foreign portfolio flows. Should foreign investors balk at adding U.S. exposure—whether due to valuations or alternative opportunities—the result would be clear: weaker asset prices, a weaker dollar, or both.
Relative growth no longer a buffer
U.S. economic exceptionalism is now in doubt. While past dollar strength often hinged on growth differentials, that pillar appears wobbly. Goldman Sachs’ recent forecast cuts underscore this shift, trimming U.S. growth expectations more severely than those for major peers. The macro tailwind may be fading.
Short-term: a tactical bounce?
While the longer-term view remains bearish, recent market structure suggests a reprieve may be in store. Since mid-January, the dollar index has plunged sharply, with the DeMark sequential indicator (see chart) now signaling a potential counter-trend move. Oversold conditions and sentiment extremes could catalyze a brief rally.
Further, the dollar’s decoupling from G7 yield spreads, captured in the second chart, hints at a short-term mispricing. If yield differentials reassert their influence, a bounce in the greenback may follow. But this would likely prove fleeting—a technical correction within a broader structural downtrend.
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Wishing you the best,
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Federico Polese
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