Softer dollar may rattle global credit

THE global credit landscape could be heading for a shake-up if the US dollar keeps sliding. A weaker greenback may look like a passing phase, but for credit markets, it’s a test of resilience that could ripple through sectors from banking to manufacturing.

According to Standard & Poor’s (S&P) Financial Services, the story isn’t just about currency charts – it’s about confidence.

“The depreciation and increased volatility of the US dollar could be one of two things,” it points out.

“Fleeting and inconsequential. Or it could evolve into a longer-term trend with broad credit ramifications.”

That statement sets the tone for what the agency calls a nuanced, and potentially far-reaching, shift in financial conditions.

S&P’s new analysis considers how a sustained decline in the dollar would alter credit quality across asset classes and geographies, mapping both “direct and indirect implications of a depreciating greenback on credit conditions” and “potential contagion effects and feedback loops to watch for across ratings practices”.

The base case in S&P’s framework assumes a modest and orderly depreciation of the US dollar against the euro, yen, Canadian dollar, and most emerging-market (EM) currencies over the next three years.

The credit rating agency expects the US Federal Reserve (Fed) to cut interest rates by 75 basis points (bps) in 2025 and a further 50 bps in 2026, with lower rates likely to weigh on the US dollar in the coming quarters.

That gentle weakening, in theory, creates both winners and losers.

Winners and losers

Export-driven economies in Europe, Japan, and parts of Asia could feel the squeeze, while US exporters and domestic manufacturers may enjoy a competitive lift.

“A weaker US dollar is likely to be moderately positive for US exporters, domestic manufacturers with a high share of dollar-linked costs and sovereigns, financial institutions or companies with significant dollar debt in EMs,” S&P notes.

The reality on the ground, though, is already moving faster than expected.

“The pace of the dollar’s weakening in 2025 has been notable,” S&P says, pointing out that the trade-weighted dollar has fallen by almost 8% since mid-January, reversing the previous quarter’s sharp rise.

What’s interesting is how much of this shift comes from sentiment, not fundamentals.

“We consequently see the current depreciation as driven by a temporary loss of confidence in US asset markets,” S&P observes. “In other words, an emerging risk premium on US assets,” it adds.

That loss of confidence was amplified by politics. April’s new tariff announcements rattled investors, while debates around the sweeping One Big Beautiful Bill Act (OBBBA) – and its potential to blow out the fiscal deficit – added fuel to the fire.

“First, the tariff announcements dented investor confidence in the US growth outlook; Second, market attention turned to suggestions that the OBBBA legislative package could increase further the fiscal deficit,” S&P says.

Even questions about the Fed’s independence, however fleeting, led some in the market to question the Fed’s independence, though the agency insists “we do not see the independence of the Fed as being at risk or in question”.

Still, with the greenback now roughly back to its September 2024 level, S&P sees only “a modest and orderly” slide ahead.

The agency expects the dollar index to settle about 1% lower over the next year, with the yen and euro gaining further ground.

Knock-on effects

Many EM currencies, especially in Asia, have already appreciated more than forecast.

“Growing capital inflows could lead to more EM currency appreciation, especially if the Fed lowers interest rates more aggressively than we expect,” S&P adds.

In credit terms, a slightly weaker US dollar isn’t yet a crisis trigger. “We have not taken rating actions solely linked to the depreciation of the US dollar,” S&P confirms.

The decline is relatively recent and contained to a few currencies. Moreover, hedging has increased against the depreciation of the US dollar, especially in EMs where issuers are using financial hedges more widely.

The knock-on effects will take time to filter through.

“A weaker US dollar will gradually feed through operating, financial performance, and margins over the next few months,” S&P says.

The agency expects the overall impact on credit quality to vary widely depending on where companies sit in the global supply chain.

Roughly 40% of rated US corporates, for instance, generate more than 20% of their revenues abroad and could benefit from currency tailwinds. Banks, on the other hand, are largely insulated – at least for now.

“US dollar depreciation is likely to have a diffuse and largely indirect effect on global banks and financial institutions,” says S&P.

Most large lenders effectively manage their open positions and maintain limited net open market positions.

Still, there are regional nuances. Japanese and Taiwanese banks, for example, face profit pressure.

“Major Japanese banks face comparatively greater risk in our view, as a 10 yen per US dollar strengthening could affect profits by 2% to 4%,” S&P calculates.

Taiwanese lenders, meanwhile, could lose out as swap gains fade from the wide rate gap between the US dollar and the new Taiwan dollar.

EM banks may even find a silver lining.

“In EM banking systems such as Turkiye, Nigeria, Egypt, and Indonesia, we could see moderate improvements in leverage and capitalisation due to higher borrowings or lending in US dollars,” S&P says. The same goes for some Australian non-bank institutions still reliant on US funding.

What worries S&P more is the tail risk – a prolonged or chaotic US dollar slump that shakes investor faith.

“A downside scenario would entail a significantly weaker US dollar and a sharp rise in the greenback’s volatility over the next three to five years,” it warns.

In that case, the economic and credit impact could become broader and more significant, it highlights.

Given that the US dollar represents more than two-thirds of the global financial system, the stakes are clear.

Further volatility could disrupt both the US Treasury market and increasingly intertwined and complex global financial markets.

And if a sharp move were to expose a big leveraged position – say, a failed trading bet by a highly leveraged hedge fund or a sudden capital flight – the ripple effects could be profound.

In summary, a mild US dollar retreat might simply reset valuations after years of strength. But a deeper slide, mixed with policy missteps and market nerves, could redraw the global credit map.

In S&P’s words, “the impact could be compounded by high global debt levels, increasingly complex and integrated financial systems, and less transparent segments of the financial infrastructure such as derivatives, private credit, and hedge funds”.