The decision by Fitch Ratings to strip the US of its AAA sovereign credit rating by a notch has reignited the debate about the US dollar’s role as the cornerstone of the global currency order, according to Swiss banking group UBS.
However, there is no imminent threat to the greenback’s status and Switzerland's largest bank said it expects a US dollar-centric world for years to come.
Last week, the US was stripped of its top-tier sovereign credit grade by Fitch, which criticised the country’s ballooning fiscal deficits and an “erosion of governance” that has led to repeated debt limit clashes over the past two decades.
The agency cut the US one level to AA+ from AAA, echoing a move made more than a decade ago by S&P Global Ratings.
Fitch said it expects US government debt to rise to 118 per cent of gross domestic product by 2025, compared with a median of about 39 per cent for AAA-rated nations.
“From a cyclical perspective, we expect the US dollar to weaken and are most preferred on the euro and the Japanese yen,” said Mark Haefele, chief investment officer at UBS Global Wealth Management.
“However, our call for a weaker US dollar in the near future is not based on the assumption of a declining global currency status.”
Both factors Fitch cited to downgrade the US’s credit rating are unhelpful in sustaining the USD’s role as the linchpin of the global financial system, according to UBS.
It seems realistic to expect the landscape to become more diverse going forward, with several currencies and even commodities playing critical roles, UBS said.
Global currency regimes are sticky, the bank said.
“The US dollar dominates financial markets and international trade. Changes in the world’s dominant currency have historically taken a long time to materialise,” according to the UBS report.
“Even as great economic powers rise and fall, their currencies’ reserve status tends to survive well past the peak of their influence.”
The latest International Monetary Fund survey on the currency composition of global foreign exchange reserves reveals that the share of US dollars held by central banks still stands at almost 60 per cent, the report showed.
The greenback is also used in more than 40 per cent of every global payment and dominates 85 per cent of trade finance contracts, according to Swift data.
The US dollar also continues to stand out as the world’s most liquid currency, UBS said.
The depth of the US Treasury bond market is second to none, the report noted.
The US dollar was on one side of 88 per cent of all global currency trades in 2022, according to the Bank for International Settlements.
“It remains solidly in first place when it comes to derivatives such as forwards, swaps and options,” UBS said.
“This is relevant, since the ability to hedge exposure to a given currency through derivatives appeals strongly to reserve managers and those involved in international trade.”
Despite all the challenges the US financial and political system is experiencing, the country still ranks highly in various gauges, including rule of law, regulatory quality and efficiency, and market openness, UBS pointed out.
chief investment officer, UBS Global Wealth Management
As a result, the US continues to attract large flows of foreign investment.
The US must treat the privilege of being able to issue the world’s pre-eminent assets with respect, the report said.
The prospect of yet another federal government shutdown in October does not improve the country’s reputation, it added.
While competition for the dollar is rising, UBS said it does not see any leading rival to dethrone the currency in coming years.
This was illustrated by the UBS annual reserve manager survey, conducted this year among 40 central banks from all regions.
When asked which reserve currencies or assets are most likely to benefit from macroeconomic and geopolitical shifts over the next five years, reserve managers provided a wide range of answers, rather than a single competitor, the UBS report showed.
