The dollar has always prevailed in every crisis. But now the signals are contradictory: declining real yields, stretched equity valuations, and emerging alternative safe havens. What if this time were different?
For years, the dollar has been the safe haven par excellence. The currency that, for better or worse, represented stability and protection in times of global uncertainty. Can we continue to talk about it in the present tense, or is it time to start talking about it in the past tense? Something has cracked, and even if Jerome Powell continues to reassure the markets, the question remains: will the greenback really be able to return to the top?
The macroeconomic picture: inflation, rates, and the dollar
Let’s start with a seemingly simple, but probably misleading, assumption. The Federal Reserve’s dot plot still points to two rate cuts by the end of the year, while expectations for the core PCE—the Fed’s preferred inflation gauge —are for a 0.2% increase month-over-month (m/m). In other words, inflation appears to be gradually cooling.
Theoretically, if nominal rates fall and inflation remains stable or only slightly declining, real rates—that is, the inflation-adjusted return—real yields decline. And this is where the link with the dollar becomes evident. When real rates fall, US Treasuries become less attractive, and global investors have less incentive to hold USD. At that point, capital flows tend to shift to other currencies with tighter monetary policies or with a positive yield spread.
The result is that the dollar’s position as a safe haven risks weakening. Yet, as often happens in markets, what seems so clear in theory may not materialize in practice.
Powell and the Confidence Paradox
In his latest conference, Powell caught markets off guard. On the one hand, he emphasized that US stock markets are "expensive," only to quickly reverse his approach and say that there are no specific risks of instability. An ambiguous message, leaving room for different interpretations.
The reasoning, however, is straightforward. If Treasuries offer declining real yields and, at the same time, the Fed itself hints that stocks are overvalued, then the question is inevitable: what’s left to support the dollar? The answer, however uncomfortable, is that very little remains.
In an international portfolio, holding dollars today means exposing themselves to FX losses that is no longer justified by the returns of the underlying assets.
Hedged ETFs: a signal from the markets
Investor behavior speaks clearly. Demand for Hedged ETFs, i.e., those that include a currency hedge, is growing strongly. This is a sign that investor confidence in the dollar is waning. More and more investors are choosing to pay a premium rather than suffer the effects of the greenback’s devaluation.
Interestingly, currency-hedged ETFs have outperformed their non-hedged counterparts at several recent points. A clear example is the S&P 500 index. The iShares S&P 500 EUR Hedged UCITS ETF (Acc) eliminates euro-dollar exchange rate risk, while the iShares Core S&P 500 UCITS ETF (Acc) remains exposed to it. During years of dollar weakness, the hedged version performed better than the traditional one.
The fact that hedged instruments are increasingly attracting capital is not a marginal detail: it represents a structural shift in investor preferences and an acknowledgement that the dollar is no longer seen as an automatic hedge.
The Global Portfolio Dilemma
This scenario raises a crucial question for portfolio construction. For decades, the implicit rule was simple: in a crisis, you bought the dollar. Today, however, that rule appears less solid.
The key issue is assessing whether maintaining excessive exposure to USD still makes sense, given the decline in real interest rates and the lack of underlying assets offering adequate returns. At the same time, we must ask ourselves what alternatives could serve as safe havens: gold, the yen, the Swiss franc, or new asset classes like cryptocurrencies.
Furthermore, the growing popularity of hedged ETFs raises a further question: how much is it worth paying to hedge exchange rate risk? If the dollar’s bearish trend were to consolidate, hedging could represent not only a defensive option but also a source of generate additional returns.
The important question
And this is precisely where the most important consideration arises. If everything seems to be going against the dollar—from falling real rates to unattractive bonds to overpriced stock markets—what could support the dollar?
This isn’t about fueling panic or hypothesizing extreme scenarios. Rather, it’s a call for awareness. The certainty that the dollar will always hold up may no longer be so obvious.
So a legitimate question should arise in every investor: if the dollar ceased to be a safe haven, how would my portfolio strategy change? It’s a question with no immediate answers, but it’s worth asking today, before the markets dictate it tomorrow.
Original article published on Money.it Italy 2025-10-02 12:45:00. Original title: E se questa volta il dollaro non si salvasse?
