A secular decline in the USD, if with annoying headline risks.

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US President Trump has been out lashing out at “Mr. Too Late” Fed Chair Powell to cut rates, which triggered a fresh slide in the US dollar. It is all feeling like a bit too much in the near term, and it is worth noting that, while the US dollar did fall and US long yields did rise (further erosion of the faith and credit of US long-term debt), the short end of the US yield curve remained rock-steady. I like the argument that this is less about the beginning of a campaign to get Powell fired and more about Trump looking for scapegoats for weak US equity markets, his declining popularity and an incoming US recession. I’m sure at least the US Treasury Secretary Bessent would prefer to flex the power of the US treasury on issues like exempting US treasury holdings from the banks’ Supplementary Leverage Ratio (SLR) to improve treasury market liquidity to lower long US yields. In theory, the Fed has this power, but it is in a gray zone.

While near term direction in the USD is just impossible because of headline risk and how far we have traveled so quickly of late, it might be a good idea to repeat the key drivers of USD weakness in this update. Chief among them is the “end of US exceptionalism” theme as Trumps’ tariff threats and attempt to restructure the terms of the US relationship with the rest of the world are a profound disruption of the US dollar system that underpins global finance. This means an exodus from US treasuries and US equities as portfolio managers second guess the incredible over-allocation to US-based assets. That allocation was always the flip-side of the US dollar’s status as the primary global reserve currency: the decades of massive US external deficits showing up in US capital markets in the form of massive foreign investment in US-based assets. With Trump calling time on US deficits both trade and (theoretically) fiscal, the capital flows would need to slow and even go into reverse as the deficits decline. An erosion of the US dollar’s status would mean an erosion of its value.

The more mundane driver of USD weakness over the coming perhaps three to nine months is the risk of a US recession due to a combination of:

• fiscal drag (at minimum net zero real growth in public outlays even if DOGE impact may prove smaller than thought)
• a widespread weak consumer sentiment and a debt-stressed lower half of the income distribution.
• The negative wealth effect for the highest 10% of incomes and most wealthy that drives nearly 50% of consumer spending
• corporate management uncertainty remaining high and investment held back as long as tariff chaos clouds the outlook.

What could brake the USD decline in the very near term, besides excessive positioning, would be a sudden clarification/breakthrough or change of tone from Trump on trade negotiations with key partners like Japan and the Eurozone. Longer term, bulls on the US economy will point to hopes for Trump to switch from a focus on trade to one of deregulation and tax cuts. But the overwhelming geopolitical structural shift that drives our expectation of a secular decline in the US dollar dominates.

Chart: GBPJPY
As outlined above, it is worse than difficult to stitch together a short-term argument for USD direction, so I will pull in one from left field for today, which is sterling versus the Japanese yen as the US and Japan are locked into negotiations trade. This has taken USDJPY to the key chart level at 140.00, while GBPUSD has risen to test the 3-year highs above 1.3400. The focus has been chiefly on the US dollar for good reason, but going forward we can trace out a couple of scenarios, both of which arguably point to GBPJPY declines. The first is that Japan has much to gain from weakening its currency in trade negotiations with the US, while this is a non-factor in the US-UK relationship. The second is that, if US Treasury secretary Bessent manages to finesse the US 10-year yield down like he so badly wants to, it is a distinct JPY positive from the traditional yield-spread angle while more neutral to only slightly UK positive (only strongly positive if lower US yields drive a significant revival in risk sentiment). Alternatively, if US yields remain disorderly, it is likely due to shaky confidence in the US and poor market liquidity – these are likely JPY positive, while they are extremely sterling negative as the UK faces the same “faith and credit” problem when sovereign bonds are under pressure because it is, like the US, a debtor nation, and not one that has the global reserve currency. In short, we see the weight of risks pointing lower in the medium term and will watch the 184-185 area in GBPJPY with interest for a run to perhaps the 179 area to start, but why not into the 160’s eventually?