De-dollarization risks aren't priced in despite rising US dysfunction and tension with China, JPMorgan says

The dollar is "very expensive in historical terms, suggesting that a narrative of secular dollar decline is not prevalent in the market."

• De-dollarization risks aren't priced in despite rising US dysfunction and tension with China, JPMorgan said.
• The dollar is "very expensive in historical terms, suggesting that a narrative of secular dollar decline is not prevalent in the market."
• Investors should go underweight on the dollar, as well as US markets, bonds, and financial equities, analysts said.

De-dollarization risks aren't priced in despite rising US dysfunction and tension with China, JPMorgan said.

In a note Tuesday, strategists said that so far there isn't much evidence of de-dollarization. While the dollar's share of international reserves dropped from 73% in 2001 to 58% in 2022, its share in sovereign wealth funds has grown, more than offsetting the decline in reserves.

But that also points to the risks that are not yet reflected in financial markets.

"Evidence for de-globalization and de-dollarization to date is not clear and unambiguous. This leads us to the view that these risk scenarios are not currently priced in by the market," JPMorgan said, adding that "the dollar is currently very expensive in historical terms, suggesting that a narrative of secular dollar decline is not prevalent in the market."

Growing competition between Beijing and Washington could play a notable role in fragmenting the currency's hegemony, the note said, as a potential "Cold War 2.0" would result in a multipolar world order and unwinding globalization.

China could accelerate de-dollarization with key financial and economic reforms, such as opening markets, improved liquidity, easing capital controls, reducing regulatory risk, and promoting Chinese government bonds.

Meanwhile, economic and political instability within the US will also factor into the credibility of the dollar, JPMorgan added. 

"For example, political dysfunction could stymie efforts to restrain the rapid growth in the national debt projected by the CBO, potentially leading to fiscal dominance or preventing a government from stabilizing the economy during a crisis due to fiscal constraints," the note said.

While "rapid and deep" de-dollarization is unlikely in the next decade, investors should expect partial de-dollarization, with the yuan rising among Chinese partners, strategists predicted.

To prepare for this outcome, JPMorgan suggest that investors go underweight on the dollar, as well as US markets, long-duration bonds, and large financial equities, which benefit when the world needs to transact in dollars.