📈  Chart of the Week 3/2/2025
By Michael Allison, CFA
Whither the Dollar?
This week’s Chart illustrates a striking divergence in real effective exchange rates, with the U.S. dollar (USD) surging to 145 from its re-based 2012 level, while the Japanese yen (JPY) has collapsed to 53. However, beyond this stark contrast, the broader story reveals a significant reshaping of global currency valuations. The euro (EUR), British pound (GBP), and Chinese renminbi (RMB) have all experienced varied trajectories, each shaped by differing monetary policies, economic conditions, and global capital flows.
The USD’s recent strength has been driven by the Federal Reserve’s aggressive rate hikes since 2022, but this dynamic began to take shape in the aftermath of the Great Financial Crisis, reversing the decline in the USD in the prior decade. The combination of economic resilience and persistent inflation pressures has created a perfect storm for prolonged dollar strength.
In contrast, the JPY’s dramatic weakness stems from the Bank of Japan’s (BoJ) unwavering commitment to ultra-loose monetary policy, keeping rates near zero while the rest of the world tightens. This has widened yield differentials, encouraging capital to flow away from Japan and toward higher-yielding assets elsewhere.
The euro and British pound have taken a middle ground. The EUR, currently around 100, has been relatively stable, benefiting from the European Central Bank’s (ECB) tightening measures. However, eurozone growth concerns have prevented a stronger rally. Meanwhile, the GBP, at 108, has seen some recovery from post-Brexit lows but remains under pressure due to the UK’s fiscal challenges and uncertain growth outlook.
The Chinese renminbi (RMB), at 105, has been more resilient, partly due to China’s managed exchange rate system. However, slowing economic growth, property sector woes, and capital outflows have weighed on the currency. While the People’s Bank of China (PBoC) has avoided aggressive devaluation, continued monetary easing and weak domestic demand could limit RMB strength.
Looking ahead, currency markets could mean-revert as central banks shift policy stances. If the BoJ signals a pivot, the yen could stage a sharp recovery. If the Fed cuts rates meaningfully or U.S. growth slows, the dollar could retreat. Meanwhile, Europe’s ability to navigate economic stagnation and China’s policy responses will be critical in determining future currency trends.
Extreme currency dislocations don’t persist indefinitely—history suggests an eventual realignment. What the catalyst for that will be is something investors should be focused on because of the significant implications such a realignment will have for asset allocation decisions.
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