“US(D) exceptionalism” is not going away
Key takeaways
- Although equity investors have been adjusting their regional allocations away from the US dollar, there is little sign this is happening in bond markets where yields remain high and alternatives to the dollar are limited.
- Although global central banks have been diversifying their FX reserves, this has been happening for a number of years and is not a consequence of recent trade uncertainty. The limitations of alternatives such as gold and the euro should limit any significant sale of US Treasuries (UST).
- Credit markets are dominated by the US dollar. Even the most geographically diverse fixed income markets, such as global investment grade corporate, is 66% US dollar denominated. This figure itself is deceptive with a large portion of euro issuance – the second highest currency – financials.
- Despite hedging costs, investors hedging into euros have achieved better results than those exposed to dollar volatility or invested in euro-based strategies year to date. (Past results are not a guarantee of future results)
Although equity investors have been adjusting their regional allocations away from the US dollar in recent months, there is little sign this is happening in bond markets, where yields remain high and alternatives to the dollar are limited.
Central banks have been diversifying their FX reserve exposure from the US dollar since 2018. In our view, it is unlikely there will be significant further reductions in US dollar FX reserves as there are not many alternatives.
Gold has benefited from the current volatility in the US Treasury (UST) market as it has been perceived as safe-haven asset, but it remains very volatile which limits its ability to represent a large component of the FX reserves. On the other hand, the euro can be considered an alternative to UST but the size of the high-quality German government bond market (€1.5trillion) remains a fraction of the UST ($14trillion), limiting its use.
Therefore, while central banks will likely continue to gradually diversify their FX reserves, the structural limitations of any alternative should lower the risk of direct sales of UST.
Meanwhile, credit markets are also dominated by the US dollar. Even the most geographically diverse fixed income market, global investment grade corporate, is 66% US dollar denominated. This figure itself is deceptive, with a large portion of euro issuance – the second highest currency – in the financials sector.
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Flavio Carpenzano
Flavio Carpenzano is an investment director at Capital Group. He has 20 years of industry experience and has been with Capital Group for four years. He holds a master’s degree in finance and economics from Università Bocconi. Flavio is based in London.
