The "Left Side Failure" of the Dollar Curve - When the Dollar is No Longer a Safe Haven

In the traditional understanding of financial markets, the US dollar has always played an important role as a safe-haven asset. Especially when risk aversion sentiment rises, investors tend to flock to dollar assets, driving up the dollar exchange rate.

This logic perfectly aligns with the left side of the classic "dollar smile curve" theory—when the global economy is in decline or market risk aversion sentiment increases, the dollar is sought after as a safe haven, showing an appreciation trend.

However, in recent years, this "law" seems to be failing. When global risk events are frequent and stock market volatility intensifies, the dollar has not shown the previous strength, but rather often fluctuates in the same direction as risk assets, which raises a deep question in the market: Is the dollar still a safe-haven asset?

A recent report from Citigroup may provide an answer to this question.

The Citigroup Adam Pickett team pointed out that the way the US maintains its "Exorbitant Privilege" has undergone a fundamental change—the traditional "Exorbitant Privilege" is reflected in the dollar's status as a reserve currency and the resulting huge demand for US Treasuries (USTs). However, now the pillar supporting America's "Exorbitant Privilege" has quietly shifted to the US stock market (SPX).

This shift profoundly affects the dollar's performance in risk-averse environments, leading to the gradual failure of the left side of the dollar smile curve.

The Shift of "Exorbitant Privilege": From US Treasuries to US Stocks

The term "Exorbitant Privilege" was originally proposed by French politician Charles de Gaulle and later formally used by economist Valéry Giscard d'Estaing to describe the asymmetric advantages enjoyed by the US due to the international reserve status of its currency.

For a long time, the dollar's "Exorbitant Privilege" has mainly been reflected in the global demand for dollar assets, especially US Treasuries. Whenever the global economy faces uncertainty or market risk appetite declines, funds flow into US Treasuries, which are seen as the safest assets, thereby pushing up the dollar exchange rate and providing the US with cheap financing to offset its current account deficit and fiscal deficit, known as the "twin deficits."

However, Citigroup's report reveals that in recent years, the driving force behind America's "Exorbitant Privilege" has undergone a structural change. The demand from foreign investors for US assets is no longer primarily concentrated on US Treasuries, but has significantly shifted towards the US stock market.

The report points out that since 2020, foreign investors have become net buyers of US stocks, and this net holding scale is expected to surge dramatically in 2024. By early 2025, the scale of foreign investors holding US stocks will reach unprecedented levels. This shift means that the funding sources for the US balance of payments increasingly rely on unstable equity capital inflows rather than relatively stable bond capital inflows

The Logic of the Dollar's "Left-Side Failure": U.S. Stock Sell-Off and Capital Outflow

The shift of the "over-privileged" pillar has directly led to the anomalous performance of the dollar in a risk-averse environment. The traditional logic is that when risk aversion rises and the stock market declines, investors will sell risk assets and turn to safe-haven assets. U.S. Treasury bonds, as one of the main safe-haven assets, will naturally be in demand, thereby driving up the value of the dollar. This is precisely the logic of the left side of the dollar smile curve.

However, the current situation is entirely different. Due to foreign investors holding a massive amount of U.S. stocks, once risk aversion sentiment emerges and triggers a sell-off in U.S. stocks, these foreign investors will massively sell U.S. stocks and withdraw funds from the United States. This capital outflow will instead put downward pressure on the dollar, causing the dollar to decline in tandem with U.S. stocks, completely overturning the traditional safe-haven logic.

Analysis from Citigroup's report shows that in recent years, during "risk aversion" periods (defined as when both the S&P 500 index and the U.S. 2-year Treasury yield are below their 55-day moving averages, and the cross-asset volatility index is above 1), the dollar has performed significantly weaker against most G10 currencies, contrary to the predictions of the traditional left side of the dollar smile curve.

The report further points out that compared to bond investors, stock investors typically have a lower foreign exchange hedging ratio. This means that when foreign investors adjust their U.S. stock holdings, the impact on the foreign exchange market will be more direct and significant. Considering that foreign investors hold up to $13 trillion in U.S. fixed income assets, even a slight increase in the hedging ratio could lead to massive dollar selling pressure. However, what truly has a decisive impact is still the net long positions of foreign investors in the U.S. stock market, which amount to trillions of dollars, along with the associated risk exposure.

Data Support: Foreign Investor Holdings and Dollar Performance

The report indicates that the scale of foreign investors holding U.S. stocks, relative to the total market capitalization of the MSCI Global Index, has reached a historical high. This means that overseas investors have never been so heavily invested in U.S. stocks as they are now. Once a sell-off in U.S. stocks occurs, the scale of capital outflow triggered will be astonishing, and the impact on the dollar exchange rate will also be significant.

The report also analyzes the investment situation of different regional investors in U.S. stocks. Data shows that while European investors net export equity investments to the U.S., the overall net equity investment position in the U.S. has also turned positive, making Europe a potential area for capital inflow. Citigroup estimates that if Eurozone investors reduce their U.S. stock positions to the five-year moving average level, as much as $930 billion could flow back from the U.S. stock market to European stock markets

Recent market performance further confirms this trend. During periods of risk aversion, we observe that while U.S. stocks decline, U.S. Treasury yields fall, and market volatility rises, the dollar also weakens simultaneously, rather than strengthening as in the past. This is completely contrary to the traditional logic of "risk aversion -> capital flows into the U.S. -> dollar appreciation," strongly supporting the view of the dollar curve's "left-side failure."

Potential Beneficiaries and Future Outlook

The weakening of the dollar's safe-haven attribute, along with the trend of capital flowing out of U.S. stocks, may present opportunities for other assets. Citigroup believes that the euro may be one of the main beneficiaries. European economies have previously faced issues of under-asset allocation, and the decline in U.S. stocks and capital repatriation may encourage European investors to increase investments in their local markets, thereby boosting the euro exchange rate.

Looking ahead, Citigroup believes that the policies implemented by the Trump administration, such as cutting government spending and increasing tariffs, may further increase the downside risk for the U.S. stock market and reinforce the trend of the dollar's "left-side failure." The report points out that the "Trump Put" and "Fed Put" may both be far below market expectations, making it difficult to effectively prevent the decline of U.S. stocks.

This means that for some time to come, the dollar may struggle to regain its former safe-haven aura, and investors need to reassess the risk attributes of the dollar and adjust their corresponding investment strategies