The USD Bear Trap and EM USD Debt

Is the Dollar forming a ‘bear-trap’?

Even though the medium-to-long term US Dollar fundamentals remain unimpressive, due to a combination of large external imbalances, a continuous dependence on foreign investors’ inflows and the weaponisation of the currency, the Dollar became the least bad currency in G4 since the beginning of the Ukraine war. After all, the US is the only country of the four largest blocks in the world (US, China, European Union, and Japan) that is a net exporter of strategic resources like energy and food, and therefore not suffering as much as the other economic blocks as these basic materials become scarce.

From a fundamental perspective, we believe the USD rally is unsustainable, as for it to continue requires more inflows to the greenback. However, the US has become dependent on capital inflows to its overpriced equity markets. After all, foreign investors hold USD 14.8trn of US stocks and USD 7.7trn of US Treasuries in Q4 2021, the latest data from the US Treasury.1 The net between foreign assets and liabilities is a staggering USD 18.1trn, equivalent of 75% of the US GDP. As foreign investors realise that the secular outperformance of US stocks is unlikely to persist given current positioning and high valuations, rebalancing away from the US to other markets is likely to lead to a weaker, not stronger USD. While this is a long-term trend, in the short term there are a few factors suggesting the greenback may be peaking.

The key market-related drivers for the strong increase in the Dollar index since February (Figure 1) was a combination of a more hawkish Fed (Figure 2), a weak JPY driven by outdated monetary policy by the Bank of Japan (Figure 3) and increased political and geopolitical risks in the Euro Area. With the USD index more than 10% above its post-Covid lows, several analysts are calling for a breakout higher in the Dollar Index. We believe a US dollar ‘bear trap’ may be forming as all these dynamics are close to a peak, in our view. To be sure, the key levels may still be broken, but further large moves from here are unlikely to prove sustainable.


In Europe, French President Emmanuel Macron has just won the presidential election, putting him in a good position to remain a strong leader within Europe, driving more public expenditure across the block.