The dollar correction is finally here

The dollar appears set to embark on a multi-year correction against a wide range of currencies, even without a trade war, as the dollar’s lofty Wall Street valuation runs up against Main Street reality.

- Stephen Jen

After the announcement of broad-based tariffs on US President Donald Trump's “Liberation Day” on April 2, global equity markets experienced a violent correction, and the dollar initially weakened — undermining the consensus that tariffs equal a strong dollar.

This episode has raised the question of whether the “Dollar Smile” has stopped working, as this rule of thumb would suggest that a risk-off scenario should lead to a strong dollar. But I don’t think the dollar smile is obsolete. What's happening is that the dollar's lofty clearing price in asset markets is finally converging with its real value in the goods market.

Trade globalisation has enriched the rest of the world over the past quarter of a century, but a multi-polar real world has not been accompanied by a multi-polar financial world: the dollar and dollar assets have continued to dominate. This unipolar financial world means that there has been huge foreign demand for USD assets.

This has arguably led to an over-valuation of the dollar, ever-larger external deficits for the US and an uncompetitive manufacturing sector, as the cost of manufacturing labour has priced the US out of global markets.