Can anything stop the rise of the dollar?

The dollar is the world’s dominant currency – and as such, it plays by its own rules. When times are good, the dollar strengthens as traders pour into dollar-denominated assets; when times are bad, the dollar strengthens thanks to demand for a ‘safe haven’. 

As the chart below shows, the dollar has risen against a basket of foreign currencies since the financial crisis hit. Over the past five years, this momentum has been particularly remarkable: neither the pandemic, debt-ceiling stand-offs nor cooling international relations have been enough to really weaken the currency. It feels tempting to ask whether anything can stop the dollar’s rise and rise. 

Rate cuts could create bumps in the road 

There is the possibility that US rate cuts could throw a spanner in the works. As hopes for US rate cuts receded, two-year Treasury yields surged, rising from 4.1 per cent in January to 4.8 per cent today. The higher yields available on US assets have attracted international investors, strengthening demand for the dollar. Thanks to the Fed’s ‘higher for longer’ narrative, most of the world’s major currencies have weakened against the dollar this year. As the Fed moves to cut interest rates (or hints that it is preparing to), the greenback could start to weaken.

Because we think about the price of one currency in terms of another, the dollar will also be impacted by the actions of central banks elsewhere. Higher for longer interest rates in the UK or the Eurozone (which is taking a cautious approach to rate cuts) could divert investors' interest away from the world's reserve currency. Traders also suspect that the Japanese Ministry of Finance sold dollar reserves to buy yen at the start of last month. The $60bn intervention saw the currency strengthen from a historic low of ¥160 to ¥153 against the greenback. Further Japanese interventions to bolster the Yen could see further gyrations.

But it will be hard to topple the dollar

Over the longer term, some economists also fear that the dollar’s position as the king of the currencies is looking more precarious. The first problem is that US debt is high – and rising. James Lord, Morgan Stanley’s head of emerging market foreign exchange strategy, warns that market confidence may erode if government debt continues to rise, with “greater risks” emerging if the position doesn’t stabilise by 2030. 

Another debt ceiling stand-off could cause ructions before then. As last year’s ‘x-date’ loomed, Stephen Kaplan, associate professor at George Washington University warned that stand-offs created an incentive for “enterprising countries and institutions” to try to find an alternative – and sanctions are only heightening the appeal. Since 2014, the Chinese and Russian central banks have sold off dollar-denominated assets, moving out of US Treasury holdings and into gold instead. 

There is not (yet) a credible alternative 

But for now, the fact remains that there is no real alternative to the greenback. It still makes up almost 60 per cent of (disclosed) central bank reserves. Most commodities, including oil and gas are still invoiced in dollars, while over the past 25 years, half of all global transactions have been tied to the currency. Such is its position in the global financial system that about half of dollar-denominated cross-border loans don’t involve any US lenders or borrowers at all. 

These statistics speak for themselves: the US is unlikely to lose its reserve status, simply because there isn’t an alternative. Wells Fargo economist Brendan McKenna, said that fears of the dollar’s demise “represent more noise than they do substance”, adding “long live the dollar as the global reserve currency”.

All this suggests that predictions of the reserve currency's demise look overblown. Morgan Stanley analysts think that although the dollar has potential to dip as interest rates are cut, it will be bolstered by its dominance as a reserve currency. Even over the shorter term, this means that it is unlikely to enter a bear market. “Hold on to your dollars,” they said.