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It was only a few months ago that everyone was focusing on the U.S. economy’s exceptionally favorable fundamentals: growth was solid; driven by migration, the labor force was expanding; inflation was receding; and business formation was robust. Adding to this, U.S. capital markets were the envy of the world, as were the research centers that were advancing the technological (e.g. productivity) frontier. These elements of American exceptionalism helped push the real effective value of the dollar to a near-40-year peak in January.

How quickly things change. Chaotic policies – tariffs, overtly preferential treatment, deportations, attacks on universities, slashed research funding, and general increases in policy uncertainty – risk inhibiting growth, sparking inflation, retarding investment, and stunting technological development. Unsurprisingly, this disturbing new mix is leading many people to anticipate a decline of the dollar and to speculate about the loss of safe-haven status for U.S. Treasuries (see our recent post).

In this post we discuss key fundamentals — including heightened policy uncertainty, dollar overvaluation, and the unsustainable fiscal path — that encourage expectations of a shift away from dollar assets and lend credence to private forecasts of a large dollar depreciation. If these projections prove correct, the key question is whether dollar adjustment will be smooth, or whether there will be a will there be a “sudden stop” where global investors abruptly halt (or even reverse) capital flows into the United States?

Recent developments in financial markets are leading people to ask an uncommon question: are global investors, both domestic and foreign, losing faith in U.S. dollar assets? The most prominent evidence for a loss of confidence is the post-April 2 simultaneous decline in the U.S. dollar, the U.S. equity market, and U.S. bond prices, accompanied by a surge in the price of gold. There also are signs of a rising risk premium on those U.S. assets (Treasury issues) that had long been viewed as the safest on the planet (see here).

Previously, when a global shock sharply boosted market risk, investors fled into Treasuries. This time really has been different. In this post, we explore the new risky pattern in U.S. asset markets and consider various explanations, including a change in relative inflation expectations and heightened pressure on intermediaries to deleverage.

The simplest hypothesis is the most troubling: that global investors are losing confidence in the United States and fleeing U.S. assets and the dollar. At this point, we lack hard data to confirm this bleak proposition. However, there may be little warning of an intensified shift away from U.S. assets. If that happens, it will be too late to find low-cost ways to “de-risk” exposure to chaotic U.S. policy developments.