MW Can the dollar regain its A-list status? Whatever happens will impact your wallet.
By Steven B. Kamin
It seemed that nothing could end the U.S. currency's reign as the 'safe-haven' for financial markets. Then came the Trump tariffs.
Since President Donald Trump declared his "liberation Day" on April 2, touching off a bout of severe financial market turmoil, the financial media has resounded with reports that the end of the U.S. dollar's DXY global dominance is here.
The basis for these calls was not just the sharp fall in the dollar that followed Trump's announcement. As indicated in the chart below, the dollar had been falling since January. Rather, the concern was that the dollar was falling even as volatility in financial markets, as evidenced by the VIX VIX index, was spiking.
The dollar is considered a "safe haven" currency. During times of volatility and crisis, its value generally rises as investors pile into it. When the dollar fell alongside the spike in the VIX in early April, financial market commentators, myself included, judged that investors were reacting adversely to the extraordinarily capricious and disruptive policies of the Trump administration.
As shown below (Fig. 1), the commentators were on to something. In the two months after liberation day, the sensitivity of the dollar to increases in the VIX plunged from positive to substantially negative. In other words, the dollar shifted from being a safe-haven currency to a risky, emerging-market style currency.
Read: U.S. debt and the dollar were the envy of the world. Trump is breaking that spell.
Most recently, the sensitivity of the dollar to the VIX has retraced some of its decline, but it remains well below its pre-liberation day value. Time will tell whether the dollar can eventually recover its earlier exceptional status - much will depend on the tone and direction of Trump's policies.
Fig 1. VIX volatility index and DXY dollar index, Jan. 1-June 20, 2025
To track investor attitudes toward the dollar, my colleagues and I estimated an econometric model that explains daily movements in the dollar based on movements in interest-rate differentials (U.S. rates minus foreign rates) and the VIX measure of volatility.
Increases in U.S. rates relative to foreign rates should attract capital from overseas and boost the dollar, while increases in the VIX should encourage safe-haven flows that also cause dollar appreciation. (Details are available here.)
The chart below (Fig. 2) presents the difference between the actual daily movements in the dollar and those predicted by the model, with the normal range of these misses indicated by shading. It shows that, because the dollar declined while the VIX soared after liberation day (as discussed above), changes in the dollar fell below their predicted values by the greatest margins in the past four years.
Read: Trump's latest tariff talk is doing something interesting to the dollar
Fig 2. Daily changes in the DXY index of the dollar: Actual minus predicted
The change in the behavior of the dollar can be seen even more clearly in the chart below. Based on our model, the chart plots the sensitivity of the dollar to changes in the VIX, estimated for 30-day moving windows over the course of the four-year estimation period. For most of this period, the sensitivity is positive, indicating that when market volatility rose, risk-averse investors shifted into safe U.S. dollar assets and the currency appreciated.
But in the two months after liberation day, this sensitivity plunged into negative territory, reaching its lowest level in the entire sample period. Essentially, the dollar became the type of currency that investors get out of when conditions get rocky.
Read: The dollar is having its worst year since Nixon. Three reasons it will get even weaker.
Fig 3. Sensitivity of the dollar to the VIX
The chart above (Fig. 3) shows that after initially plunging to record lows, the sensitivity of the dollar to the VIX started to reverse its earlier sharp decline starting in June. So it's too soon to assess whether a lasting break in the dollar's flight-to-safety role has occurred.
One possibility is that with markets continuing to recover from the shock of liberation day - the VIX is down and the stock market is up - the sensitivity of the dollar to the VIX will eventually climb back into positive territory, signaling the return of the dollar's safe-haven status.
Another possibility is that the sensitivity of the dollar to the VIX will stabilize at near-zero, indicating a loss of safe-haven status, but stopping short of becoming a full "risk-on" emerging market-style currency.
Finally, it is possible that the response of the dollar has depended on the source of the market's volatility: turbulence triggered by Trump's trade war may have undermined the dollar's flight-to-safety character, while turbulence triggered by foreign geopolitical events - such as the eruption of the Iran-Israel-U.S. hostilities - may have helped restore it.
The weeks and months to come will shed more light on which of these possibilities is most likely. But it is clear that the best chance for the dollar to retain its exceptional role in international finance is for Trump to eschew the shambolic missteps of liberation day in favor of more measured, prudent and cooperative economic policies. I wouldn't hold my breath.
Steven B. Kamin is a senior fellow at the American Enterprise Institute $(AEI)$, where he studies international macroeconomic and financial issues. He is a former director of the division of international finance at the U.S. Federal Reserve Board.
More: The dollar could continue to trade like a 'risky' currency, Goldman Sachs warns
Also read: Leading emerging markets strategist says the long American century is over: Place your bets on China, not the U.S.
-Steven B. Kamin
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July 16, 2025 07:45 ET (11:45 GMT)
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