Don't be fooled by short-term rebounds! Goldman Sachs warns: The US dollar is facing structural depreciation

One-liner: Uncertainty won't fade quickly, don't be misled by short-term relief rallies...

This is the latest view put forward by Rikin Shah, an analyst from Goldman Sachs' FICC team, in a research report published over the weekend.

Shah believes that while the US's hard data remains resilient and labour market data has yet to show imminent warning signs, news of further tariff cuts or a "trade deal" could inject relief sentiment into the short-term market. However, caution is warranted as risks have not yet been eliminated – if we are heading into a period of more severe growth weakness, such weakness may take time to manifest.

Shah mentioned several reasons for the recent stability of US hard data, which has not shown a significant downturn:

For instance, front-loading of corporate purchases may have actually pushed up spending data in parts of March and April, as currently observed. And since labour market fluctuations are more likely to stem from slower hiring rather than mass layoffs, the role of initial jobless claims as a warning signal may also be weaker than usual.

The Goldman Sachs team believes that the negative economic effects of Trump's policies may not become clearer until mid-May or early June. Given the high level of policy uncertainty and low consumer and business confidence, Goldman Sachs' Global Investment Research (GIR) still forecasts a 45% probability of a US recession in the next 12 months.

Meanwhile, despite the Trump administration's previous 90-day suspension of reciprocal tariff increases on certain countries and other exemption measures, a significant amount of tariffs remain in place – even with negotiations, it is difficult to see a reversal below the 10% benchmark tariff rate, which is already substantial.

The US Fed is "reacting passively"

The Goldman Sachs report points out that, given the inflationary impact of tariffs and the uncertainty surrounding the ultimate path of trade and fiscal policies, the US Fed is currently in a reactive rather than proactive mindset.

This stands in stark contrast to the period during Trump's first round of trade wars, when the Fed had a lower threshold for interest rate cuts.

Shah stated that most Fed officials, including Chair Powell, currently emphasize the need to keep inflation expectations anchored. Therefore, the Fed may need to see actual weakness in hard data – particularly deterioration in the labour market – before taking action. If unemployment does rise significantly, the Fed's dual mandate will trigger a rapid response.

Goldman Sachs believes that in the event of a recession, the Fed could cut interest rates rapidly and substantially – by more than 200 basis points. This scenario has already led the market to price in a larger reversal in Fed policy in the second half of 2026 and 2027, while the current challenge lies in determining the timing of the first rate cut :

We are in a difficult period filled with uncertainty: 1) the outcome of tariff negotiations is uncertain; 2) the impact of tariffs on global growth and the labour market is unknown. Even if there is short-term relief, it is important to remember that uncertainty persists. If the market becomes complacent due to short-term data resilience, it should consider increasing its exposure to downside risks.

The depreciation of the US dollar is structural

The Goldman Sachs team believes that, despite potential exchange rate fluctuations triggered by tariff-related news (especially potential agreements), the long-term trend of US dollar depreciation is set to continue. The US dollar is the most natural adjustment tool against US tariffs, uncertainty, and recession risks – the broad and unilateral nature of this round of tariffs reinforces this logic.

When US businesses and consumers become price takers, and if supply chains or consumers lack short-term elasticity, the US dollar may need to depreciate to achieve adjustment. The deeper logic lies in the fact that the recent strength of the US dollar has been driven by private capital inflows driven by excess returns on US assets.

First, a large number of leveraged investors hold US dollar assets in an unhedged manner – there is significant room for an increase in hedging ratios.

Second, even if existing US dollar asset holders do not actively reduce their holdings, future marginal demand may shift. The over-allocation of US assets took years to build up and may also take years to unwind. In the past, private capital inflows into the US have been a key driver of US dollar strength.

Note: Share of US dollar assets in global portfolio investments

In fact, Goldman Sachs' Chief Economist, Jan Hatzius, recently stated:

The US dollar's real effective exchange rate is still nearly two standard deviations above its average since the era of floating exchange rates began in 1973. The only two periods of similar overvaluation in history – the mid-1980s and early 2000s – both ended with the US dollar depreciating by approximately 25-30%.

Note: The red line represents the average from 1973 to 2025

The IMF estimates that non-US investors currently hold up to $22 trillion in US assets. Therefore, once non-US investors decide to reduce their exposure to US investments, it will almost certainly lead to a significant depreciation of the US dollar... while even if non-US investors simply become reluctant to increase their US investment portfolios, it could still put pressure on the US dollar.