The U.S. dollar is experiencing a continuous decline against the euro and the yuan, driven by growing global pressure to expand the role of these currencies in the economic arena. Ahead of China’s Lunar New Year holiday, the yuan recorded its strongest performance against the dollar in three years, with the dollar losing 6% of its value against the Chinese currency since the beginning of last year. At the same time, the euro rose by 15% against the dollar, approaching its highest level in five years.
These movements follow recent statements from European and Chinese officials. Last week, the European Central Bank announced plans to expand euro liquidity to other countries, strengthening its international use. Additionally, Austrian Central Bank Governor Martin Kocher highlighted growing interest in the euro from other nations, reinforcing its status as a safe-haven currency.
In China, President Xi Jinping stated on February 1 his country’s intention to expand the use of the yuan in global trade and international reserves, signaling a strategic shift to boost the yuan’s role in the global financial system.
There appears to be a shift in global thinking regarding dollar dominance, as investors begin reassessing heavy reliance on the U.S. currency within the financial system. This comes amid trade and diplomatic tensions with the United States, creating an opportunity to expand the use of the euro and the yuan. However, markets remain hesitant to abandon dollar supremacy, reflecting a sense of anticipation for what the near future holds.
Despite the dollar’s decline against both the euro and the yuan, the exchange rate between the two currencies has not changed significantly since the U.S. tariff shock in April. For regions with close trade ties, this stability is crucial, especially as the dollar weakens against these currencies.
The yuan currently accounts for 15.5% of the euro trade weighted basket at the European Central Bank, close to the dollar’s 17.4% share. Similarly, the euro represents 18% of China’s trade weighted yuan basket. Yet, the euro’s share in the U.S. dollar trade weighted basket at the Federal Reserve stands at 21%, more than double the yuan’s 10% share. This indicates that any weakness of the dollar against the euro or yuan quickly affects the value of these currencies.
For cross-border investors, particularly in government bonds, long-term currency valuation plays a significant role when choosing between high yield U.S. bonds and lower yield Chinese or European bonds. For instance, the yield advantage of U.S. bonds over Chinese bonds could be entirely offset if the dollar falls 10% against the yuan between now and 2031, making Chinese bonds more attractive.
China continues to invest its liquidity in U.S. bonds, but there are increasing moves by Chinese regulators to encourage domestic investors to reconsider concentrating their investments in U.S. debt. These measures add further downward pressure on the dollar.
The ongoing decline of the dollar against the euro and yuan may signal the beginning of a fundamental shift in global currency dominance. While Europe and China aim to expand the role of their currencies, the dollar still maintains its position as the primary reserve currency. However, with growing calls to strengthen the euro and yuan, the question remains how this shift will impact the global economy in the near future.
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