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FX update: is the market sleepwalking into something big?

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3 minutes to read by  G.Kalani, BlueBay Fixed Income Team Mar 25, 2025

Key takeaways

  • Month and quarter end are skewed towards heavy USD buying flows from rebalancing.

  • The outcome of tariff decisions on 2nd April could see the dollar return to a position of strength.

  • Even in a weaker USD environment, there could be significant counter-trend rallies within that.

This month end/quarter end rebalancing from pension funds and asset managers could be historic. Why? The extent of underperformance of US assets versus international assets this month and quarter has been historic. Hence to keep asset weights the same as before, the rebalancing towards US assets would also be historic.

Obviously, there is a chance that pension funds decide to rebalance less than what is mechanically implied i.e. accept a lower weight of US assets in their portfolios. However, this would be an active investment decision and they may not have had enough time to make that decision, given the typical pace of such activity. As such, I think the risks into month end and quarter end are skewed towards heavy USD buying flows from rebalancing.

2nd April has been dubbed ‘liberation day’ by Trump, a day when major new tariffs are expected on a wide range of trading partners. To date, tariff delivery has been random, messy, and focused on Mexico/Canada (which are intertwined with US supply chains) – hence the impact on US confidence and US assets has been negative, leading to asset rotation and dollar weakness.

However, the question must be asked: what if the next round of tariffs on April 2nd are better thought out, not immediately backtracked, and are focused on countries which are not as crucial to the US supply chains?

The administration has obviously had much longer to prepare for these tariffs than the earlier ones which have seemed more ‘off the cuff’. In such a scenario, we could easily see the dollar return to its ‘traditional’ tariff trade, which is dollar stronger / US outperforms peers / growth impact on other countries is more negative than for the US. In my view, this possibility is clearly significant enough to at least warrant some reversal in recent dollar weakness.

The above points are in the context of positioning in the dollar – we entered the year with the market extremely long dollars, but all of that positioning has now unwound, and positioning has moved to small short dollars. Obviously, this is not extreme, but provides more room for a USD rally on tariff concerns than at the start of the year.

There is a clear possibility of a broader, medium-term asset rotation / USD weaker trade around a potential end to US exceptionalism. This is a broader discussion, but the point is that even if a longer-term USD downtrend has just begun, there could be significant, tradeable counter-trend rallies within that, and the current setup could be one such instance, in my view.

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