US Dollar

Macroeconomics and Politics
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10

Assessment USD Dollar and EURUSD as of April 20, 2025

EUR/USD: Recent Movements and Drivers

  • The recent weakness in the dollar seemed to be driven by foreign capital outflows, as evidenced by foreigners selling US assets lately, and the U.S. market’s underperformance relative to the rest of the world in Q1 2025, German Bund yields widening against treasuries, and with gold outperformance.
  • Foreign investors, have previously reduced their hedges for their exposure to U.S. assets from ~ 80% to 55% currently (the lowest in years), so they are now more vulnerable to USD depreciation. As the dollar weakens further, they may pre-emptively cut U.S. holdings or reintroduce hedges, adding to the pressure on the USD.
  • A rise in U.S. trade deficit in recent months, partly from forward purchasing, has contributed to dollar outflows and supply. However, this is likely a secondary factor, and a temporary one.

Bullish EUR/USD (Bearish USD) Case

  • The dollar appears overvalued by ~10% to 20% (GPT) by several metrics, particularly after several years of exceptional U.S. performance and elevated expectations. This makes the bar for the dollar high, and a reversal is increasingly likely with ongoing headwinds
  • The U.S. faces structural drags, such as tariffs, reduced immigration, gov spending cuts, Fed independence threats, civil unrest, etc. The US entered 2025 with very high expectations for 2.1% real GDP Growth, and currently the risks of even are recession are higher.
  • While the Eurozone may benefit from new fiscal stimulus. Even if EU growth expectations remain subdued, the relative outlook is slightly improving.
  • U.S. growth headwinds, including weaker-than-expected economic outlook and prospects for rate cuts (~125 bps priced in in US vs. ~75 bps in the EU), are narrowing the rate and growth differentials that had previously supported the dollar against the euro.
  • Global portfolios were heavily tilted toward the U.S. heading into 2025, increasing U.S. risk factors (political risks and uncertainty in the U.S) could be prompting a rotation out of USD assets for diversification purposes ( relative risk premium on US assets is rising), not a rejection of its reserve status, but foreign investors, who have benefited from both U.S. stock gains and currency appreciation, are likely to take profits and rebalance their portfolios
  • The combination of falling German Bund yields, rising U.S. Treasury yields, and dollar weakness suggests a reallocation of foreign capital away from the U.S., especially if investors believe the dollar’s relative yield advantage is peaking.
  • Trump’s policy stance seems to favor a weaker dollar. Reduced emphasis on maintaining a strong dollar may increase downside risk.

Bearish EUR/USD (Bullish USD) Case

  • Trade protectionism from the U.S. could hurt Europe more than the U.S. given the Eurozone’s greater reliance on exports (~20% of GDP vs ~11% for the U.S)
  • European exporters may also suffer supply chain disruptions or lose access to U.S. markets if trade tensions escalate, needing to find alternatives, reducing investor appetite for European assets eventually.
  • Trade tensions between the U.S. and the rest of the world could create a global slowdown (WTO is already expecting a global trade volume decline in 2025 ). Further moderation in U.S. data only could push EUR/USD even higher medium term, while severe tariff impacts could do the opposite.
  • Historical precedent shows the dollar tends to strengthen (GPT 1, 2) during high global stress (which remains a constant threat given rising geopolitical risks and trade volatility) since dollar supply usually declines (less trade volumes, more risks aversion to lending) and dollar demand tends to be more inelactic.
  • A decline in U.S. trade deficits also implies fewer dollars send abroad (US imports $4.1 trillion per year), tightening global dollar supply, and potentially strengthening the currency because of the funding and settlement needs.
  • A U.S. recession could also widen fiscal deficits even more (currently ~2 trillion) and drive higher supply for U.S. Treasuries, squeezing dollar supply further.
  • If Germany’s fiscal stimulus falls short in implementation or impact, the recent euro optimism may prove temporary. Much of the euro’s recent strength is sentiment-driven and could fade without hard data support.
  • Sticky U.S. inflation due to tariffs may delay the Fed’s pivot to cuts, maintaining higher U.S. rates and supporting the dollar.
  • In case of a deeper correction in U.S. equities or bonds, more attractive valuations may draw foreign capital back into the U.S., increasing dollar demand.

Final Assessment:

  • In the short term, I would not be surprised to see the EURUSD dollar in the 1.20-1.30 range, due to the ongoing capital outflows currently, and deteriorating US outlook.
  • In the medium term, I would see two scenarios:
    • Economic weakness is specific to the US only (25% probability)–> this would lead to further weakening of the dollar → maybe could see above ~1.30 EURUSD
    • If Economic weakness spreads to the rest of the world (75% probability) → this would lead to a stronger dollar due to less global trade volume and less risk aversion in funding markets (less dollar supply available), and dollar demand being more ineslastic (GPT) → probabily returning to the 1 -1.1 range.

My probabilities here are still with very low confidence

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