USD: US-EU trade disputes spark risk aversion in markets – BBH

US-EU Trade Disputes Impact Global Markets

Ongoing trade frictions between the United States and the European Union are dampening investor confidence, leading to declines in both global stock and bond markets. Meanwhile, gold has surged to unprecedented highs. Interestingly, the US Dollar (USD) is not following its typical pattern during periods of market stress, as it has weakened against most leading currencies, especially the Euro (EUR). According to BBH FX analysts, the EUR/USD pair has climbed nearly 1.5% since the start of the week.

Understanding the Recent Dollar Decline

The recent softness in the USD appears to be driven by increased currency hedging activity from international investors who hold US dollar-denominated assets, rather than a broad move to divest from American markets. Supporting this, US Treasury International Capital (TIC) data reveals that, in the twelve months leading up to November, overseas investors acquired a record $1.569 trillion in long-term US securities, including Treasury bonds, corporate debt, equities, and government agency bonds.

Eurozone's Treasury Holdings and Market Impact

The notion that the Eurozone could leverage its US Treasury holdings as a bargaining chip in escalating trade disputes with the US is unlikely. The Eurozone holds the largest share of US long-term Treasuries among foreign investors, accounting for 21% of all foreign holdings. However, due to the vast size and liquidity of the US Treasury market, even coordinated selling by Eurozone investors would have only a modest effect on Treasury yields. In fact, Eurozone-held US long-term Treasuries represent less than 5.5% of all outstanding Treasury securities.

Long-Term Outlook for the US Dollar

Looking ahead, persistent doubts about US trade and security strategies, along with potential political interference in the Federal Reserve’s independence, could further erode the dollar’s status as the world’s leading reserve currency—a long-term challenge for the USD. In the short run, however, the dollar is expected to remain within the trading range established since June of last year. Most major central banks have concluded their easing cycles, but the Federal Reserve still has the flexibility to implement additional rate reductions.