Market Thoughts: Castles made of sand

Treasury Secretary Rubin christened the strong dollar policy in 1995, after a decade of dollar decline. He grounded its need as national interest. The U.S. hasn’t looked back. Wavering sentiment makes the dollar vulnerable to pronounced bouts of volatility.

A strong dollar supports financial stability. It can add to the trade deficit. Manufacturing export competitiveness is diminished, even before factoring in relative labor costs. Not to mention countries that subsidize domestic manufacturing or manage their currency. Insert any observation you’d like about tariffs.

Dollar policy before Rubin’s decree was more laissez-faire, at the whim of the market. Rubin recognized a strong dollar as fundamental to curb inflation. Also, to attract and maintain foreign investment. Integral for credibility and trust. It helps sell Treasury securities.

Stability is foundational to the dollar serving as global reserve currency. There’s been modest erosion of its dominance, but from pole position. It won’t be given away quickly. That said, for the White House a weaker dollar seemingly rhymes with tariffs.

The U.S. benefits from what’s called the dollar smile. Strong in good times and bad. A stable dollar acts as a safe haven when global markets riot. It promotes investment when the U.S. economy is strong. Unless the storm happens to be the U.S., then we get a dollar frown.

Since Rubin, the U.S. Treasury’s mantra has been strong dollar, strong economy. When there’s conjecture an administration prefers a weak dollar, things can get bumpy. A depreciating dollar challenges faith in the U.S. The stability counted on to hold long-term investments. You know, safe harbor.

A weaker dollar is tolerated when driven by fundamentals. When the dollar’s viewed as expensive. We saw that last year. Recent yen weakness hasn’t been helped by the Bank of Japan dragging its feet on raising rates in the face of inflation. Fiscal profligacy is a rising concern. Sound familiar?

With U.S. monetary policy on hold, interest rate differentials today aren’t weighing on the dollar. When the Federal Reserve cuts rates (and others don’t) it can weaken the dollar. It matters how other central banks are setting monetary policy. Portfolio flows chase after higher yields.

The European Central Bank’s (ECB) been able to hit pause on easing because they’re trending right around their inflation target. An appreciating euro, especially after last year, might force the ECB to rethink additional rate cuts. A strong euro weighs on growth. It hits jobs and earnings. Ironically, lower European interest rates might help stabilize the dollar.

Gold’s been a clear beneficiary of central bank reserve diversification. Also, fearmongering around U.S. commitment to a strong dollar policy. It’s abated thanks to Secretary Bessent’s reaffirmation that the U.S. Treasury maintains it. Trust, but verify.

Reserve diversification into gold is real. We looked at official world reserves tracked by the International Monetary Fund and measured gold holdings in market value. A decade ago, they represented about 10% of total reserves. At the end of September they’d risen to about 25%. Gold’s rallied +40% since then.

For good measure we looked at U.S. Treasury data of foreign official institutional (which includes foreign central banks and governments) holdings. They have fallen from about 30% of outstanding Treasury securities a decade ago, to under 15% as of November.

Now throw into the mix meme mania, as retail money plows in. Anything that moves up at the parabolic rate we’re seeing in gold and silver could benefit from a breather. Or a pullback. Too much of a good thing eventually isn’t.

I came into the year thinking the worst of dollar weakness was behind us. We’re seeing a bit of it again. It’s not helped by swirling narratives of debasement. Perception of a crack in the dollar as reserve currency can be extinguished. It needs to be.

If left to fester, expect raucous markets. Investors are grounded in the strength of the U.S. economy and earnings. Fundamentals prevail, but good news is the consensus view. Temper exuberance. It’s not a moment for unrestrained risk-taking. Those tend to come after a fall.

“And so castles in the sand / Fall in the sea eventually…” Jimi Hendrix

Unless explicitly stated otherwise, all data is sourced from Bloomberg, Finance LP, as of 01/29/26.

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