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(Bloomberg) — Washington’s spending spree endangers the global status of the dollar as a reliable safe haven, according to Eurizon SLJ Capital’s Stephen Jen.
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Continued US fiscal imprudence and a return to “quantitative easing could jeopardize the global standing of the US Treasuries and undermine the left side of the dollar smile,” the firm’s CEO Jen and economist and portfolio manager Joana Freire wrote in a Tuesday note.
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Jen is known for the “dollar smile” theory that he put forward more than two decades ago. The framework suggests that the greenback strengthens when the US economy is either strong or in a deep slump. For now, the left side of the smile, when the dollar rallies amid risk-off episodes, “can still be counted on,” according to the strategists.
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“In response to the Iran War, the markets only had a brief period of risk-off, during which the dollar also had a mild rally,” they wrote. “The size of the rally in the dollar was modest only because the markets didn’t stay scared — fearful of a recession — for that long, and the Treasuries were pricing in a bigger inflation risk than a recession risk.”
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A gauge of the dollar rose in March to post its best month since July, after the US attack of Iran upended global energy markets. The greenback later walked back those gains as hopes rose on the end of the conflict after a ceasefire in early April.
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The Federal Reserve began purchasing large amounts of US Treasuries, mortgages and even some credit exchange-traded funds in 2020 to help lower market interest rates. That era of quantitative easing ended after March 2022, when the Fed began raising rates from near zero.
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The Trump administration’s expansionary budget has already cast doubts on whether the US can sustain such spending. The Supreme Court decision earlier this year to strike down sweeping global tariffs imposed by President Donald Trump threatens the budget deficit further.
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Fitch Ratings warned last week the US’s credit grade faces the challenges of a widening deficit that leaves its debt burden “far above” other nations that share the same score.
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“Japanese government bonds and the yen used to be reliable safe havens but have largely lost their safe-haven traits due to Japan’s large public debt and persistent quantitative easing,” the strategists wrote. “It is crucial for the US to avoid repeating the same policy errors if the Treasuries are to retain their safe-haven status, on which the curvature of the left side of the Dollar Smile is predicated.”
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—With assistance from Michael MacKenzie.
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English (US)