The "collapse" of the US dollar is underway: a mass exodus is overwhelming, but it's just the beginning?

According to Zhitong Finance APP, this year the US dollar exchange rate has plummeted like an avalanche, and many believe that this downward trend will soon ease. However, analysis shows that this is neither a short-term speculative behavior nor a cyclical adjustment; the true recovery of the dollar may still take several years.

So far this year, the US dollar index has fallen nearly 10% against major currencies, marking the worst first half since 1986. At that time, the dollar was deeply mired in the aftermath of the "Plaza Accord"—the consequences of the five-nation coalition's efforts to suppress the dollar's overvaluation at the end of 1985.

Given the tendency for excessive reactions in the foreign exchange market, whether the dollar has indeed been oversold and is about to undergo a technical correction is indeed worth discussing. The latest global fund manager survey from Bank of America seems to support this view: short positions on the dollar have reached a 20-year high, and "shorting the dollar" has become one of the three most crowded trades globally, second only to "going long on gold" and "going long on the seven tech giants in the US stock market."

Crowded trades are often seen as contrarian indicators, suggesting that the market may have overbet.

However, history shows that certain crowded trades can persist for quite a long time. Take the "seven tech giants in the US stock market" as an example; this trade has consistently topped the list of crowded trades in Bank of America's monthly surveys for the two years ending in February this year, with related ETF prices more than doubling during the same period, only experiencing a correction at the end of last year.

Indeed, highly speculative or leveraged trades are more likely to reverse quickly. However, the current short positions on the dollar by speculators in the foreign exchange market are far from historical extremes. According to the CFTC's weekly reports, while the net short position on the dollar reached a two-year high in April, it has been continuously reduced since then—yet the dollar's downward trend persists.

Is a rebound imminent?

In the short term, the foreign exchange market is caught in a tug-of-war between two forces—on one hand, the Federal Reserve may release dovish signals, while on the other hand, conflicts in the Middle East are pushing up oil prices, leading dollar traders to be divided in their direction.

Spot traders are selling the dollar against most currencies, causing the dollar index to hover near a three-year low on Wednesday, as the market awaits the Federal Reserve's policy decision to be announced later that day. Traders generally expect Chairman Powell to acknowledge that recent data shows core inflation in the US continues to slow, which could be a precursor to interest rate cuts later this year The currency market is currently betting on a 50 basis point rate cut before the end of the year, with a 68% probability of the first rate cut starting in September.

However, the sentiment in the one-month options market has shown a reversal, with the risk reversal indicator indicating that traders have unwound their bearish positions for the first time in four months. The escalation of the conflict between Israel and Iran has pushed up oil prices, and the United States, as a net exporter of oil, has seen rising oil prices indirectly support the dollar exchange rate.

Elias Haddad, a strategist at Brown Brothers Harriman, pointed out: "The escalation of military tensions in the Middle East may strengthen the dollar's safe-haven attributes while suppressing risk assets. However, we believe the dollar's upward momentum is difficult to sustain, partly because the Federal Reserve is expected to maintain a dovish stance at this meeting."

According to interbank traders, the divergence between the spot and options markets reflects that the market is readjusting dollar positions amid multiple narratives. Analysts at ING believe that Tuesday's dollar rebound may include short covering factors. If oil prices continue to rise, in a geopolitically driven market, the dollar may still have room for upward movement, at which point the impact of Federal Reserve policy will take a back seat.

"Core Logic"

However, from a long-term perspective, what truly deserves attention is the degree of underweighting of the dollar by asset management institutions. A Bank of America survey shows that institutional avoidance of dollar assets has reached a 20-year peak, stemming from concerns about the current U.S. trade policy, geopolitical stance, and institutional integrity, as well as reflecting the broader trend of structural weakening of the dollar. Interestingly, even after a 10% depreciation, nearly two-thirds of respondents believe the dollar is overvalued.

Interest rate differentials are usually the driving force behind cyclical fluctuations in currencies, but the current decline of the dollar clearly has other complexities. Vincent Mortier, Chief Investment Officer at Amundi, a European asset management giant, stated: "The current core logic is that funds are shifting from U.S. assets to European and emerging market bonds."

Jeff Currie from Carlyle Group pointed out that long-term factors such as the reshaping of the geopolitical landscape, national defense, and energy security are suppressing the dollar.

Currie's analytical framework shows that the U.S. withdrawal from international affairs (such as recent Middle East policies) is pushing up global risk premiums. As tariffs and capital costs rise, market liquidity continues to drain, ultimately leading to a weaker dollar, rising commodity prices, and increased demand for heavy asset sectors such as defense—he believes this will drive countries capable of investing in these areas to achieve higher growth and innovation.

He emphasized: "This is just the beginning of a larger-scale capital shift—funds will move from 'light asset' industries to 'heavy asset' industries, which form the backbone of the global supply chain and are more tilted towards Europe."

To support his viewpoint, Currie outlined the previous two rounds of capital migration lasting about two years: from "BRICS" to U.S. tech stocks in 2014-2015, and from the internet bubble to BRICS markets in 2002-2004—coincidentally, these were also periods when institutional dollar positions were at their lowest in the Bank of America survey

"Considering the undervaluation of European assets, robust fundamentals, and defense fiscal spending, we are confident that a new round of capital rotation towards Europe is underway," Currie summarized.

Of course, like all financial prices, the US dollar exchange rate will not decline in a straight line. But even if there are technical rebounds during this period, its long-term downward trend is likely difficult to reverse—even if the trade escaping the dollar has become so crowded