Be careful what you wish for on a weaker US dollar

SUDDENLY, the US dollar is back on the slide, on an inkling that Washington is ready to use more than words to reverse its longstanding overvaluation in pursuit of a global trade reset. But trying to prod gigantic currency markets into seismic shifts could get very messy indeed.

A relatively placid start to the year for foreign exchanges, despite major geopolitical ructions, had many assume that the US dollar’s precipitous early year slide in 2025 had petered out. Re-accelerating US growth and its reinvigorated asset markets had drawn a line under it in many investors’ eyes.

But the past week has seen Japanese authorities try to rope in US counterparts to defend the ailing yen ahead of elections next month. That revived speculation that Washington could take more direct action to keep the US dollar down, and perhaps even reverse years of broad dollar appreciation.

Even though no official selling of US dollars was detected, a “quote check” from American authorities on Friday (Jan 23) – often seen as a prelude to intervention – sent the dollar/yen pairing plunging. Subsequent Japanese warnings against excessive yen weakness point back to September 2025’s joint Washington-Tokyo statement.

The US dollar slide has not been confined to the yen. South Korea’s won has rebounded, while China’s yuan and Australia’s dollar hit their highest in three years. The move shifted to Europe on Tuesday, with the euro soaring to its highest level in almost five years and the Swiss franc climbing to 10-year peaks.

The US dollar’s index against the most-traded currencies – which had its worst first half of any year of the floating-exchange era in 2025 – dropped to its weakest since early 2022.

Smoking gun?

The narrative returns once more to a longstanding assumption that US President Donald Trump’s administration wants a deeper unwind of the dollar’s near-50 per cent real rise in the decade before his return to power, as part of a push to shrink US trade deficits.

Many of his closest advisers see tariff hikes and a more competitive exchange rate as central planks of any reboot of America’s industrial economy.

Despite last year’s US dollar drop, the real effective exchange rate index has shaved only about 8 per cent from the peak a year ago – and still sits 35 per cent above levels in 2011.

Although Treasury Secretary Scott Bessent has been vague about the administration’s overall attitude to the US dollar exchange rate – and may well have supported Japan on the yen simply to prevent an explosive rise in Japanese government bond yields going global – speculation has swirled nonetheless.

Inevitably, attention has returned to pre-election papers by Trump adviser – now Federal Reserve governor – Stephen Miran, which raised the prospect of a so-called “Mar-a-Lago Accord”: a multi-pronged effort to devalue the US dollar, echoing the 1985 Plaza Accord, when G5 powers (France, West Germany, Japan, the UK and US) coordinated to sell US dollars and puncture the Reagan-era surge.

But even if a weaker US dollar suits Japan for now, it is hard to see why Europe or China would sign up for a forced jump in their own currencies – especially given the rancorous state of trade and political relations with the Trump administration.

And sending any such signal to global currency markets, which turn over almost US$10 trillion a day, risks opening a Pandora’s box of other potential problems.

“Double-edged nature”

The big concern for Washington about sowing seeds of a US dollar devaluation in an election year is what that may mean for the stability of gigantic net foreign ownership of US assets – more than US$27 trillion and rising, as of late last year.

The prospect of unhedged US stocks and bonds suffering a 10 to 20 per cent US dollar hit may well destabilise that unprecedented investment imbalance – now a US liability to the rest of the world of about 90 per cent of gross domestic product. Japanese investors are the single biggest overseas holders of US Treasuries, and European investors hold US$8 trillion of US stocks and bonds.

What is more, any sudden and sharp US dollar slide would complicate things further for Fed policymakers, who are already mindful of tariff-driven imported inflation and have been signalling a longer pause in rate cuts despite political pressure.

That suggests to many that Washington may sidestep this.

“Treasury Secretary Bessent is well versed on the double-edged nature and tensions inherent in any attempt to drive the dollar significantly lower for US bond markets, inflation and in fuelling the latest round of ‘Sell US’ market narrative,” wrote SGH Macro Advisors economist Tim Duy.

Even if Mar-a-Lago Accord suspicions are fanciful, others see an anti-consensus US dollar slide resuming regardless.

Stephen Jen of Eurizon SLJ Capital reckons that the market is embarking on a second leg of a structural US dollar correction – one which he thinks can coincide with buoyant growth and stock markets, and still be consistent with Washington’s aggressive trade stance.

“In 2025, the dollar only experienced roughly one-third of its structural correction, in my guesstimate,” Jen wrote. “The next third will likely come mainly against Asia, (and) euro/dollar may rise in sympathy.”

But juggling fresh US dollar weakness, brisk growth, high debt and Fed pressure alongside the biggest long position in American assets in history may be a hard act to pull off without triggering broad market ructions or extreme volatility.

Against such an aggravated political and geopolitical backdrop, it seems even trickier. The eye-popping rise of gold over the past year does not seem so strange in that light. REUTERS