Foreign Investors Dump US Dollar Assets Amid Trade Policy Concerns, Fed Independence Worries

Foreign investors have been selling off their US dollar assets, driven by concerns over US trade policies and the potential erosion of the Federal Reserve's independence. This trend has been noted by Morgan Stanley, which highlights the challenges faced by foreign investors in finding suitable alternatives to US dollar assets.

According to Vishwanath Tirupattur, the global head of quantitative research at Morgan Stanley, the US market has historically outperformed other developed markets due to its superior economic growth and relatively stable policy environment. The US dollar's status as the global reserve currency has been further solidified, especially during times of market stress, with US Treasuries being viewed as the premier safe-haven asset.

However, recent developments have raised concerns among foreign investors. The US government's fluctuating trade policies and questions surrounding the Federal Reserve's independence have exacerbated these worries. Additionally, the growth differential between the US and other developed economies is narrowing. Morgan Stanley predicts that the US growth rate will slow to 0.6% in 2025 and 0.5% in 2026 due to trade and immigration policies. In contrast, the eurozone is expected to see a slowdown to 0.6% in 2025 but a rebound to 1.1% in 2026, thanks to fiscal stimulus. This could erode the US's growth advantage over the eurozone by 2025 and turn it into a negative by 2026.

Moreover, the correlation between the US stock market and the dollar has shifted, resembling patterns seen in emerging markets, where stock market declines are accompanied by dollar weakness. This challenges long-held assumptions about cross-asset relationships. These uncertainties may lead foreign investors to reduce their allocation to US assets in favor of non-US assets and increase their currency hedging against US asset exposures, both of which could exert continued pressure on the dollar.

Despite these concerns, Morgan Stanley points out that the US Treasury market, with a size of approximately $27 trillion, offers unparalleled depth and liquidity compared to other potential safe-haven markets, such as German bunds or Japanese government bonds. While the relative attractiveness of the euro and the yen is increasing due to market concerns, the lack of equally sized and liquid alternatives makes it difficult for foreign investors to exit the US bond market en masse.