USD will likely remain the primary global reserve asset, but challenges are emerging – Scotiabank

Fitch’s announcement that it was cutting the US sovereign credit rating by one notch to AA+ caught the market by surprise. Economists at Scotiabank analyze USD outlook.

Fitch ratings cut not fatal, but not good for the USD

The universe of solid, AAA sovereign credits has shrunk. So weak fiscal policy is not a challenge unique to the USD. The decision is unlikely to shape near to medium term trading patterns in the USD which will continue to reflect economic data and their implications for yields and interest rate differentials. 

At the margin though, the downgrade is clearly a negative for the USD. Central bank reserve managers have been trying to avoid the USD in recent years and the downgrade will give sovereign accounts another reason to diversify, if only passively, away from the USD. 

The liquidity, scale and (relative) safety of US financial markets mean that the USD will very likely remain the primary global reserve asset for the foreseeable future. But challenges are emerging, which the Fitch decision and its reference to governance highlight. 

Still, the obvious question for anyone considering moving out of the USD right now is: what alternatives are there? The answer is that no currency can offer the advantages of the USD at this point (liquidity, convertibility, track record etc.). The EUR and CNY are potential rivals for the USD but this remains a long-term prospect.