QNB Expects Further US Dollar Depreciation

QNB confirmed that there is still room for further depreciation of the US dollar over the medium and long term, despite the decline already seen this year, which it described as the steepest in the past half-century.

In its weekly report, QNB attributed this decline to the narrowing of US economic outperformance, the dollar's overvaluation, and the massive accumulation of non-resident assets in the United States, suggesting that achieving optimal adjustments in currencies will require substantial global macroeconomic cooperation.

The report said that no market rivals the foreign exchange (FX) market. With a daily trading volume exceeding $7.5 trillion, FX is the largest and most liquid financial asset class in the world. Unlike equities or bonds, the FX market operates 24 hours a day, five days a week, with major currency pairs being traded across continents.

The report noted that the sharp decline in the U.S. Dollar Index marks the worst start to a year for the dollar since 1973, when President Richard Nixon engineered the decoupling of the US dollar from gold, leading to a significant devaluation of the currency. 

The recent decline affected all major currencies included in the index basket, namely: the euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc.

The report suggested that sharp movements and expanded trader positions could lead to a short-term decline in the dollar, while conditions remain favorable for further depreciation over the medium and long term, based on three main arguments.

First, it is expected that the large growth gap between the US and other major advanced economies will narrow significantly in the coming years, effectively reducing what was referred to as "American exceptionalism." New immigration policies and limited fiscal space point to further slowing in the US, whereas leading euro area economies such as Germany are expected to adopt more flexible fiscal policies, increasing investment in defense and infrastructure.

As a result, the US-eurozone GDP growth differential, which has favored the US by an average of 220 basis points annually over the past few years, is expected to narrow to 70 basis points during 2025-2027, which would support a stronger euro against the US dollar, pushing the Dollar Index further downward, especially since the euro accounts for 57.6% of the index basket.

Second, QNB argued that the US dollar is overvalued and in need of adjustment. A common way to assess currency values is to analyze trade-weighted exchange rates adjusted for inflation (real effective exchange rates, REER) and compare them to long-term averages or historical benchmarks.

 This REER metric is considered more accurate than conventional FX rates as it captures changes in trade patterns among countries and reflects economic imbalances such as inflation differentials.

The May 2025 REER snapshot shows that the US dollar is the most overvalued currency in the developed world, exceeding its estimated fair value by more than 17%, implying that it is expected to adjust toward fair value over the medium term.

Third, cross-border financial asset positions indicate that structural rebalancing of global capital allocations could trigger a major wave of capital outflows from the United States.

The US is currently a significant net debtor to the rest of the world, with a negative net international investment position (NIIP) of $24.6 trillion. 

This position has deteriorated sharply from a marginally negative 9% of GDP at the start of the global financial crisis to 88% of GDP by the end of last year. This suggests that the US is the country where most of the global economic imbalances are concentrated.

This level of mutual exposure appears to be increasingly troubling for both creditors and debtors, necessitating substantial adjustments. This would imply greater capital outflows from the US over several years, exerting additional downward pressure on the US dollar.