Dollar depreciation: more of a shock absorber than a threat - July 21, 2025

In the July edition of Bank of America's Global Fund Manager Survey, the short position on the greenback has become the most widely accepted among institutional investors, ahead even of the ‘Magnificent 7’ and gold. Historically, such a consensus may herald a short-term turnaround, but the underlying trend remains bearish. Should we be alarmed? Not necessarily. After all, the fall in the dollar acts primarily as a macroeconomic stabiliser.

A correction after an all-time high

In January 2025, the dollar's real effective exchange rate - which adjusts the value of the dollar to price differentials with a broad basket of currencies - reached its highest level since 1985. Since then, the decline, albeit rapid, has merely brought the greenback back to a more sustainable valuation. In other words, the correction is justified, not dramatic (see chart 1).

The dollar, collateral victim of the ‘Amerexit’

The dollar's weakness also reflects the growing disaffection of international investors with US assets. Donald Trump's ‘Amerexit’ - the American version of Britain's ‘take back control’ - is making US bonds less attractive, making it harder to finance the twin deficits (budget and current account). Logically, this weighs on the exchange rate. But it is also an effective adjustment mechanism: by depreciating, the dollar relieves external pressure and partially insulates US financial conditions.

An automatic shock absorber

This is precisely the central function of a floating exchange rate regime. An emblematic example: after the Brexit vote in 2016, the United Kingdom saw capital flee. But instead of a rise in interest rates, it was sterling that adjusted - thus protecting British long-term interest rates (see chart 2). The dollar is currently playing the same role as an automatic shock absorber.

Bonus for US multinationals

A weaker dollar improves margins for US exporters. It is estimated that a 10% fall in the dollar leads to a 2-5% gain in profits. This eases domestic financial conditions, even if it is at the expense of foreign competition - particularly in Europe.

Europe can benefit

Contrary to the often-heard criticism, the depreciation of the dollar does not necessarily harm Europe. In the current context, an appreciation of the euro encourages a rebalancing towards more domestic growth (graph 3). It improves consumer purchasing power, reduces import costs and exerts a welcome disinflationary pressure. This paves the way for increased monetary support, which the eurozone sorely needs.

Conclusion : stabilising, barring a sudden shock

As long as the dollar's depreciation remains gradual, it is playing a stabilising role on a global scale. Risks only emerge in the event of sudden movements. For example, in May this year, the sudden volatility of the dollar prompted Taiwanese life insurers to rush to hedge, causing the Taiwanese dollar to soar by 10% in three days, forcing the central bank to intervene.

The good news for investors is that currency hedging is now simple to put in place. It is therefore possible to remain exposed to buoyant US equity themes while neutralising the impact of dollar fluctuations.