Bloomberg Intelligence
This analysis is by Bloomberg Intelligence Chief Asia FX and Rates Strategist Stephen Chiu.
The dollar’s broad retreat against major currencies may persist even if the US rolls back tariffs, as markets re-evaluate US economic policy, with significant implications for dollar hegemony. This has accelerated de-dollarization, a trend likely to continue regardless of immediate policy shifts.
The widely recognized “dollar smile” theory, proposed by Stephen Li Jen over two decades ago, explains how the dollar appreciates during global recessions (as a safe haven) and when US growth outperforms others (due to yield allure). However, a different pattern – the “dollar frown” – is now appearing as markets increasingly question the dollar’s status as a reserve currency. This “dollar frown” theory argues for a concave relationship between the dollar and the US economy. This structural shift could be amplified by the Triffin Dilemma, highlighting the US’s challenge in maintaining the dollar’s reserve status while running persistent trade deficits. In such a “dollar frown” scenario, investors might turn to other reserve currencies or gold during risk aversion, whereas a strong US economy might leave markets questioning the Fed’s capacity to raise rates. Between these extremes, markets might pause challenging US exceptionalism.
While we’ve upgraded our Q2 Asia FX bias due to the dollar’s earlier-than-expected decline, Asian economies still face headwinds, with impacts potentially surfacing in the second half of the year. Any trade deal might only partially reduce tariffs and could involve US collaboration to isolate China, the largest trading partner for most Asian economies. Asian exports could suffer, particularly from eroding competitiveness if dollar-Asia FX pairs sink rapidly. Consequently, Asian central banks might eventually have to step in to slow the currencies’ gains, even if doing so risks drawing the ire of the Trump administration.
Most emerging-Asia currencies, excluding Singapore dollar, have weakened multilaterally against the dollar this year as of April 8, with the dollar’s sell-off (even during risk-off windows), masking this underlying Asian currency weakness amidst rising skepticism of the US due to tariff threats. Moving forward, measuring FX performance in a basket will become increasingly crucial, especially during a reserve-currency regime shift.
If the dollar’s role as the primary vehicle currency diminishes, non-dollar currencies will be quoted and traded against other reserve currencies like the euro and yen, with the yuan also gaining prominence. As of May 2, Asian currencies were down against major non-dollar reserve currencies like the euro and Japanese yen, a trend also observed with gold, considered a reliable reserve asset during volatile periods. This is particularly relevant if the leading reserve currency provider imposes capital controls or market barriers to stem outflows.
The yuan’s downtrend against its 25-currency China Foreign Exchange Trade System (CFETS) basket, despite the dollar’s broad decline, likely reflects the People’s Bank of China’s currency bias given the dollar’s structural weakness. China’s economy remains export-reliant, making the yuan’s competitiveness against other Asian currencies and the euro as important, if not more so, than its performance against the dollar as China’s trade structure evolves.
Looking ahead, a notable theme in the FX market will likely be a shift in the importance of reserve currencies, a trend that could be effectively captured by observing a basket of non-dollar SDR currencies, with their weights normalized and funded by the greenback. The IMF’s last update to the SDR currency basket in 2022 notably increased the yuan’s weight from 10.92% to 12.28%. With the SDR basket typically reviewed every five years, the next review is anticipated to conclude before the end of July 2027.