Next up for markets: A crisis of confidence in the greenback

In times of market panic investors tend to rush to the safety of the dollar, but when stocks swooned in response to US tariffs this week, they ran away from it. Investors say it’s a sign that the greenback’s global standing may be eroding.

The dollar, for decades a safe haven, on Thursday fell about 1.7% in its biggest daily drop since November 2022, after President Donald Trump imposed tariffs on imports at levels not seen since the early 1900s. Stock markets also tanked, as tariffs ignited recession worries.

Many investors and analysts pointed to the Trump administration for the anomaly. Its protectionist policies, upending of the global economic order in place since World War II, and a growing US debt pile have been chipping away at the dollar’s appeal, they say.

Left unchecked, a crisis of confidence in the dollar could also undermine its position as the world’s reserve currency, they added.

Any erosion of the dollar’s standing as a safe-haven is bad news for investors and policymakers - at least in the near term.

For investors, who have piled trillions of dollars into buoyant US markets in recent decades, a sharp dollar fall could result in higher interest rates for longer. That’s because price pressures at home could make it harder for the Federal Reserve to cut rates.

At the same time, a rapid strengthening of currencies against the dollar is a headache for other central banks navigating a weaker economic outlook, as it makes their exports more expensive and potentially harder for them to revive growth. The euro, for example, just had its best day against the greenback in more than two years.

The recent depreciation in the dollar showed that concerns about the currency’s status had “left footprints in financial markets already,” Sweden’s central bank deputy governor Per Jansson said. “If (the dollar’s status) would change, that would be a big change for the world economy ... and would basically create a mess,” he said. “I really do not hope the US goes there.”

To be sure, despite such growing worries, the dollar is still firmly positioned as the world’s top reserve currency. Trump has said he wants it to maintain that status and warned against attempts to undermine it, while signalling a weaker dollar would be good for exports.

The currency also has an inherent competitive advantage: It’s backed by the world’s largest economy, the deepest capital markets and an established rule of law. There is no real alternative in the near term.

In addition, its fall so far this year - the dollar has slumped about 6% against other major currencies - could ease if Trump is able to turn around sentiment on the economy through pro-growth policies such as tax cuts and deregulation.

Going into the year, investors had expected Trump tariffs to boost the dollar, as they believed his policies would spur growth.

So while investors expected tariffs to be inflationary, the consensus was it would hurt economies abroad more while leading to higher rates at home, strengthening the currency.

That’s turned out to be wrong. His tariffs are so sweeping that investors now fear the US will be hurt the most by them as prices rise at home and growth slows. Several investment banks have raised the probabilities they give of a US recession.

The negative sentiment is reversing money flows into the US, thereby reducing demand for dollars. Foreign holdings of US assets had surged to $62tn in 2024, from $13tn a decade earlier as international investors flocked to outperforming American stocks, bonds and real estate, official US data shows.

But in a sign money is moving out of US assets to markets overseas, US stocks have slumped 8% so far this year, while German and Hong Kong shares have rallied roughly 12% each .

And the hit to the US as an investment destination could deepen. President Emmanuel Macron on Thursday called on European companies to suspend planned investment in the US in response to the tariffs imposed on the bloc.

Earlier this week, Deutsche Bank warned of the risk of a crisis of confidence in the US currency, while bond giant Pimco said it had turned more cautious on the dollar. Satori Insights founder Matt King said outflows from the US would likely continue.

As a result, the future of a currency often referred to as “King Dollar” for its strength and dominance in global forex markets suddenly looks uncertain.