Synopsis:

Goldman Sachs' chief economist Jan Hatzius argues that despite the dollar’s recent 5% decline, it remains significantly overvalued and poised for further depreciation. Structural portfolio imbalances and elevated valuation levels point to a multi-year adjustment.

Key Points:

• Overvaluation Still Extreme:

  • The dollar remains nearly two standard deviations above its long-term real average since 1973.

  • Comparable historical peaks in the mid-1980s and early 2000s were followed by 25–30% depreciation cycles.

• Foreign Holdings Pose Structural Risk:

  • Non-US investors hold $22 trillion in US assets, around one-third of their total portfolios.

  • About half of these holdings are unhedged equity exposures, meaning a shift in sentiment could amplify FX moves.

• Investor Rebalancing Could Trigger Declines:

  • Even a modest reduction in US portfolio exposure by international investors could drive material dollar depreciation.

  • Goldman sees this as a potential long-term headwind to the USD, rather than a temporary adjustment.

Conclusion:

Goldman Sachs believes the dollar has considerably further to fall, with historical precedent, current valuation metrics, and global capital flow dynamics all pointing toward a multi-quarter USD downtrend. Portfolio diversification and declining US asset appeal may fuel the adjustment.