Deutsche Bank: We Are in the Eye of a Market Transformation Storm, Potentially Triggering a Dollar Crisis

Following Trump's announcement of a new round of tariffs, the dollar experienced a sharp decline, causing investors to worry about a broader crisis of confidence.

George Saravelos, Deutsche Bank's Global Head of FX Research, warned even before Trump's tariff policy announcement that the broader the tariff coverage, the greater the negative impact on the U.S. itself, affecting U.S. asset risks, recession probability, and the dollar.

On the 3rd, Saravelos further noted that the breakdown in correlation between the dollar and U.S. risk assets is concerning—European losses on U.S. assets now exceed those during the 2022-2023 crisis. The dollar's safe-haven status is eroding, imposing significant costs on unhedged dollar holdings.

"All of this could lead to a self-fulfilling reversal of capital flows, with divestment from countries (most developed nations) that have been exporting capital to the U.S. over the past decade."

Fundamentally, the U.S. has a large current account deficit, and the currency's stability relies on capital inflows. Deutsche Bank believes that if the dollar falls, U.S. stocks decline, and the term premium on U.S. Treasuries rises, it would be the strongest market signal of accelerated U.S. divestment.

The term premium on U.S. Treasuries has not yet risen, but if it does, it would be a very negative signal.

Deutsche Bank warns of the risk that major shifts in capital flow allocations could overwhelm currency fundamentals, potentially leading to disorderly currency movements.

An accelerated dollar decline would be very unwelcome for central banks globally. The European Central Bank's worst-case scenario would be an external deflationary shock and significant euro appreciation due to loss of dollar confidence, in addition to tariffs.

Analysts suggest that the widespread sell-off in global markets indicates investors don't expect winners in an escalating trade war. However, it also suggests that the U.S. itself might be one of the biggest victims of Trump's protectionist policies.

We are in the midst of a dramatic transformation of market institutions, and we must remain vigilant.