When capital begins to diversify after a shock, as it did after the collapse of the Internet bubble in 2000, it portends a deep decline in the dollar.
Traders should prepare for a prolonged sell-off of the dollar, which could mirror the boom cycle and subsequent collapse of the Internet bubble era, when current currency support factors will be replaced by headwinds, RBC Capital Markets warns. Bloomberg writes about this.
The dollar has already suffered severely this year due to the uncertainty surrounding Trump's policies. However, he received support from the stock market rally and the influx of investments in American assets, primarily from large passive funds.
Over the past two decades, these global players have increasingly preferred more expensive American assets, especially stocks, and these flows in turn have supported the dollar, said Richard Kochinos, currency strategist at RBC.
"This concentration has worked well over the past 15 years, but it creates risks in the current environment," Kochinos wrote in a note. — "A significant change in demand (and relative profitability) can have a serious impact on the foreign exchange market."
When capital begins to diversify after a shock, as it did after the collapse of the Internet bubble in 2000, it portends a deep decline in the dollar, comparable in scale to the decline of the US currency from a peak to a minimum of 40% between 2001 and 2008, he wrote.
Cochinos also pointed to high asset valuations, changing trading paradigms and shifting safe havens among the challenges for the dollar in the coming years, noting that "long-term risk management should be the focus as we approach 2026."
To hedge the long-term risk of a lower dollar, RBC recommends a range of strategies, from synthetic call options on the ICE dollar index to bullish binary options on the euro and yen. Simpler structures are also recommended, including:
• two-year call option on EUR/USD with a 1.30 strike (assumes a fall in the dollar by about 12%)
• two-year put option on USD/JPY with a 130 strike (assumes a fall in the dollar by about 15%)
The RBC analysis also highlights how the current situation differs from the 2000s, especially given the growth of illiquid and private assets, which can increase fluctuations in financial markets during periods of stress.
"The historical lessons of the post-2000 period are valuable, but the unique combination of technological changes, geopolitical tensions, and monetary policy experiments today requires adaptation, as allocation structures are no longer traditional," Cochinos wrote.