Is "The Worst H1" Just the Beginning of the Story? Goldman Sachs: The US Dollar Will Fall Further...

As H1 2025 draws to a close, if investors were asked to review the most impressive market trends in the global market over the past six months, the "free-falling" US dollar would undoubtedly secure a spot on the list...

Market data shows that the Bloomberg US dollar index has fallen by over 8% year-to-date, marking the worst annual start on record. The ICE US dollar index has also declined by approximately 9% this year, likely posting the worst H1 performance since at least 1986.

Regarding the current weakness of the US dollar, Richard Chambers, global head of repo trading at Goldman Sachs Group, believes that this trend is likely to continue as foreign investors are increasing their currency hedging.

"Given heightened volatility, we do expect to see higher foreign exchange hedging ratios," Chambers said on Tuesday at an event hosted by the International Swaps and Derivatives Association (ISDA) in New York.

Chambers pointed out, "We believe that themes such as a weaker US dollar, rising foreign exchange hedging ratios, and the purchase of US Treasuries through foreign exchange hedging will become far more prevalent than they were approximately 12 months ago."

Foreign Demand to Weaken

Many industry insiders suggest that the significant weakening of the US dollar index this year is largely due to the uncertainty brought about by a series of policies from US President Trump, which have disrupted global markets and shaken investor confidence. Foreign investors' holdings of US securities (including stocks, government bonds, and corporate bonds) have doubled over the past decade to reach $31 trillion.

Currently, although there are no clear signs that overseas investors are withdrawing from the US bond market on a large scale, Chambers said he expects foreign demand to weaken in the future.This is because European investors may choose to stay in their home markets. Currently, these countries are increasing fiscal borrowing and spending, which will deepen the market for the euro as an alternative reserve currency.

"You may see more nationalistic and local investments rather than a shift towards the US dollar," Chambers said.

Chambers also stated that as a result, the US will become more reliant on domestic buyers to absorb the increasing debt and "more dependent on enhanced financial intermediation capabilities to provide leverage for the entire system."

An Indicator Flashes a "Red Light" for the US Dollar

In fact, a recent indicator in the foreign exchange market is also flashing a "red light" for demand for the US dollar.

Analysts from several banks, including Morgan Stanley and Goldman Sachs Group, have pointed out that there has been a notable shift in the so-called cross-currency basis swap recently. This indicator reflects the level of additional costs required to exchange one currency for another, beyond the borrowing costs in the cash market. When demand for a specific currency increases, this additional cost or premium rises; conversely, when demand is not as robust, it falls and may even turn negative.

These analysts found that when US President Donald Trump announced the "Liberation Day" tariffs, which caused the stock and bond markets to crash in April, the preference for the US dollar, as measured by basis swaps, was relatively mild and short-lived. Meanwhile, demand for other currencies such as the euro and the yen was growing. This contrasted sharply with the robust demand for the US dollar often seen in the past two decades during scrambles for safe assets.

The Morgan Stanley team wrote in a June report: "Recent cross-currency basis moves suggest that investors' willingness to buy US dollar-denominated assets has decreased, while their willingness to buy euro- and yen-denominated assets has increased. " The team wrote that, in fact, the impact of US tariffs appeared to have triggered a temporary withdrawal from US dollar assets.

Cross-currency basis is important because it effectively sets the price of long-term foreign exchange hedging for companies and investors around the world. It is also an indicator of changes in large-scale asset flow trends between economies and across asset classes.

Guneet Dhingra, head of US interest rate strategy at BNP Paribas, said in an interview, "Generally speaking, the theme related to this basis is: Are investors, particularly European investors, repatriating funds from the US? Our view at BNP Paribas is that there is indeed a considerable amount of cross-border capital flow, particularly from the US to Europe."

Goldman Sachs also believes that the euro may have become more valuable than the US dollar in the cross-currency basis swap market—a rare phenomenon over the past two decades.