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The chief strategist for emerging markets and China investment strategy at an independent research firm issued a warning about an imminent significant decline in the US dollar, driven by an unsustainable balance of payments situation that could fundamentally transform global investment trends.
The United States has maintained a substantial current account deficit of approximately $1.4 trillion over the last four quarters. This deficit has been primarily financed by unprecedented foreign portfolio inflows, with foreign investors purchasing US stocks and bonds in record amounts. For example, foreign net purchases of US equities reached a historic $700 billion in just the past year. However, this surge is nearing its peak, and a slowdown in inflows is expected. A decrease from $700 billion to perhaps $300 billion or $500 billion in bond inflows is likely, and a reduction in total portfolio flows from $1.4 trillion to around $800 billion or $1 trillion could lead to a massive decrease in capital supply.
Such decline in foreign funding would force the dollar to fall, especially as US consumers and businesses attempt to import goods without sufficient capital to offset their trade gaps. With less foreign investment, the dollar would weaken, causing exporters from countries like China, Japan, and Europe to face a weaker dollar, which would push them to raise prices. Additionally, currency depreciation combined with potential tariffs would make imported goods more expensive, leading US consumers to cut back. The dollar acts as the balancing mechanism for the balance of payments, and when foreign inflows diminish, the resulting contraction in imports and exports will require a significant adjustment in the currency’s value.
The researcher further analyzed that the shift in the dollar’s primary driver from interest rate differentials toward balance of payments equilibrium reflects that the Federal Reserve has limited scope to cut rates further, making the current massive deficit unsustainable. The current record foreign purchases, especially in equities, signal that this global rush is approaching its end, with future inflows expected to decline substantially, thereby forcing a correction in the dollar’s value.
He also pointed out that the high valuations in US stocks, often justified by price-to-earnings-to-growth ratios, could be a market bubble. The current valuation is based on past growth rates, which may no longer be sustainable due to a regime shift in the US tech sector. Historically disciplined, high-return US tech companies have begun investing heavily, risking overcapitalization and lower future returns in the coming years. The rapid buildup of expensive data centers and infrastructure may soon become obsolete, forcing companies to reduce prices and potentially leading to losses. These trends suggest that the high valuations do not reflect expected future earnings reliably.
Regarding emerging markets, despite cyclical headwinds such as a declining manufacturing cycle, a neutral stance is maintained—though a lower overall exposure relative to global benchmarks is recommended. The US is projected to underperform, especially given its heavy reliance on technology stocks which pose systemic risks. If current trade and growth dynamics deteriorate, the global trade volume could shrink, impacting commodity-exporting economies like those in Latin America and parts of Asia.
A key strategy includes a significant overweight in Japan, primarily as a currency hedge, given the undervalued Yen which is expected to appreciate over the next year despite short-term volatility. Conversely, while the region faces growth challenges, European markets are viewed more favorably relative to the US, as capital flows from the US are likely to diminish, causing the Euro to strengthen and European stocks to outperform slightly. This outlook hinges on the expectation that the US’s diminishing demand and trade contraction will impact the global trade environment, especially in trade-dependent emerging economies.
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