USD Down But Not Out; Going Global a Defensive Strategy; Goldilocks Alive in Europe

• The US dollar may be down, but it is not out

• The IMF view on the global economy

• US asset performance has been taxed by the tariffs

• Goldilocks is still alive in the world of global fixed income  

The other TINA

A few years ago, TINA was known as “there is no alternative” to equities. That was when you needed a microscope to spot fixed income yields. But times have changed dramatically. In any case, that is not what we are talking about here. There is another TINA. There is no alternative to the US dollar as the dominating reserve currency. The US dollar may be down, but it is not out. Can the share of the dollar in global reserves go down over time? Yes, definitely, and in fact it has.

According to the latest IMF data, the USD accounts for about 58% of global official reserves, down from about 70% 20-years ago.^[1] There is very little competition, however. The EUR is a distant second, with a share of about 20% of global official reserves, followed by the Japanese Yen with 5.8% of the total. It is likely that the share of the US dollar will continue to go down in the period ahead, but this is going to be a very slow and gradual process. The main obstacle to the potential competitors is simply market size and liquidity. Whatever your view on US treasuries is these days, the reality is that the US treasury market is more than ten times bigger than the German Bund market. In terms of the average daily volume, a useful measure of liquidity, the US Treasury market’s liquidity is 30 times as large as its European peer.^[2] In other words, the dollar and the US Treasury market are here to stay as a critical investment vehicle. Does that mean that US Treasuries are a safe haven? No it does not. There will be times when the value of US Treasuries will go down, depending on macro and cyclical factors. That principle also holds true for the US dollar itself. Over the years, we have seen strong dollar cycles and weak dollar cycles, while the share of the USD in global reserves has been consistently albeit gradually trending down.

In other words, discussing the tactical view on the US dollar and its status in the international financial system as the predominating reserve currency are two separate topics. So let’s not panic about the demise of the US dollar. At the same time, the current macro drivers are not dollar-supportive, which means that the tactical risks to the dollar are skewed to the downside. 

The global view from Washington

These days when one mentions Washington DC, people tend to think about the White House. This is understandable. But Washington is also home to the headquarters of the IMF and the World Bank, which conducted their Spring meetings last week. The news that came out of this high-level summit was not particularly good.

The IMF has substantially downgraded the outlook for global growth, mainly reflecting the impact of the surge in policy uncertainty and increasing trade tensions. Under the IMF’s baseline scenario which incorporates the impact of the US tariff announcement on April 2nd, global growth would slow to 2.8% this year, its slowest pace since 2009—excluding the 2020 Covid shock.^[3] In terms of global winners and losers, the IMF projections, as illustrated in their latest World Economic Outlook, point to both the US and China being in the losing camp. Growth in the US is projected by the IMF to slow to 1.8% in 2025 from 2.8% last year, a substantial deceleration, while China growth would slow to 4% from 5%. Within EM, the IMF expects a major growth slowdown in Mexico, Brazil or emerging Asia. In contrast, the Euro area would fare relatively better, with growth prospects for 2025 broadly stable from the year prior. Likewise, other major countries such as Japan, India, or Canada would appear to be little impacted on balance. Beyond policy uncertainty, the IMF underscores the tightening of financial conditions as a major source of downside risks, although the international institution stops short of predicting a global recession.

If anything, Market Insights is of the view that the IMF forecasts may represent the worst-case scenario, especially if we observe some further easing of trade tensions in the period ahead. In any case, the global market outlook is likely to remain characterized by elevated macro volatility, which warrants a robust investment process and strong risk management.

Also read: The High Yield Market Has Changed, And Why That’s A Good Thing!

Our tariffs, and our asset performance problem

In the early 1970s, a former US Treasury Secretary famously said: the dollar is our currency, but it is your problem. So far, it has not worked out that way for US assets. Since the major US tariff announcement in early April, US fixed income assets have indeed underperformed their peers. This is despite staging a pretty healthy performance bounce over the past couple of weeks. In IG for instance, US IG is still down by 0.53% since April 1^st, while the EUR IG index has returned a positive 0.89% during the same period (in EUR terms).^[4] 

The divergence is of course even more striking when factoring the sharp currency move, with the EUR gaining over 5% against the USD since Liberation Day.^[5] Likewise in HY, US HY is virtually back to flat since April 1^st, but EUR HY has done better during that time. Finally, in the government bond universe, the performance gap is also substantial. The US Treasury index is still down by 0.23% since April 1st, while in contrast, the Bund index has gained 1.61% (in EUR).^[6] Overall, the place to look for strong performance in fixed income is with the global indices. The global Agg, the global government, and global credit indices all have posted superior performance since Liberation Day. This is likely because of the investor perception that the US will bear the brunt of the tariff shock from a macro standpoint. With that in mind, going global appears to be an effective defensive strategy these days, with the benefits of geographical diversification, as well as relative value opportunities on the duration and currency fronts. 

Goldilocks is still alive

We have all forgotten about Goldilocks lately, but there is a case to be made that European fixed income is still enjoying a Goldilocks backdrop. The ECB plays a big part in that story. Our Head of DM Rates Strategy, Peter Goves, now believes that the ECB terminal rate could be much lower than initially thought, which represents a major tailwind not only for European duration, but also for credit. More importantly, the downside risk to the ECB policy rate is not fully priced in. Looking at the macro backdrop for the region, it is the definition of Goldilocks: not too cold so that we are concerned about a potential recession, and not so hot that the ECB would suspend its aggressive easing bias. At 108bp for EUR IG spreads, the valuation has also improved substantially.^[7] Overall, Europe remains a top pick on our global fixed income radar.