U.S. dollar safe-haven role faces AI flow risk

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Dollar safe-haven faces AI risk

Highlights

Institutional foreign inflows into U.S. equities and AI-related assets have made the dollar a crowded trade, raising vulnerability if AI confidence wanes.
Recent AI valuation pressures saw haven flows shift to the Japanese yen and Swiss franc, with the dollar gaining modestly mainly due to French civil unrest.
Analysts warn that disappointing AI returns or credit stress could spur equity and bond selloffs, provoking dollar weakness especially given record-long overvaluation and large U.S. fiscal deficits.

AI-driven inflows reshape dollar dynamics

As reported by Reuters, foreign capital has poured into U.S. mega-cap equities, hyperscaler corporate bonds and power-grid infrastructure, reinforcing the view that the dollar is a crowded trade tied to American exceptionalism. Faster growth, higher yields and persistent overseas demand for U.S. assets have helped support the currency, but analysts say that same positioning could become a weakness if confidence in the AI theme fades.

Dominic Bunning, head of G10 FX strategy at Nomura, said it is no longer clear the dollar would benefit in the same way as in past episodes if the AI trade unwinds. Kevin Ford, lead FX and macro strategist at Convera, said the link between the AI trade and the dollar has become more visible when AI valuations come under pressure.

Recent market moves offer an early signal. When AI valuations came under scrutiny last week, haven demand favored the Japanese yen and Swiss franc over the dollar, while the greenback posted only modest gains against the euro, helped mainly by concerns over French civil unrest.

Analysts say foreign flows into U.S. equities are at a record while foreign direct investment has lagged, leaving a larger share of overseas money in the hands of institutional allocators that can shift positions when they reassess U.S. growth, interest rates or technology valuations. Noah Buffam, FX strategist at CIBC Capital Markets, said the AI trade helped push U.S. rates higher, which in turn lifted the dollar.

Credit stress could test structural support

Strategists warn that if AI-related returns disappoint, the reversal could hit equities, credit and rates at the same time. Weaker growth could push the Federal Reserve toward rate cuts, reducing the dollar's yield advantage, while slower domestic investment and softer institutional demand for U.S. bonds and stocks could undermine a key pillar of support for the currency.

Erik Nelson, global head of FX strategy at Wells Fargo, compared current allocations to the kind of hot-money flows often seen in emerging markets. He said the real trade-weighted dollar has stayed above its long-run average, measured since 1973, for 12 consecutive years, the longest stretch on record, while foreign inflows are now more concentrated in equities and corporate bonds than during the 2000 technology bubble and foreign direct investment is weaker.

Nelson said an equity selloff alone would not necessarily break the dollar, noting that after the Nasdaq peaked in March 2000 the currency stayed firm for nearly two years before weakening as U.S. credit markets came under stress and global growth recovered. But he and other analysts say the current AI buildout is more U.S.-centric, which means any deterioration in credit conditions or growth expectations could have a more direct effect on the currency.

If infrastructure investments fail to deliver, credit spreads could widen and force AI companies to cut capital spending, with knock-on effects for industrial equipment, hardware and energy demand. Shaun Osborne, chief FX strategist at Scotiabank, said signs of strain are already visible in sharply wider credit default swap spreads for riskier AI-linked borrowers such as heavily indebted neocloud companies.

Analysts also note that Washington now runs a large fiscal deficit, unlike the surplus near the 2000 tech peak, leaving less room for counter-cyclical stimulus without unsettling debt markets. Nelson said the key question is whether stress becomes a U.S.-specific credit and growth problem that also shifts expectations for Fed policy, a scenario in which the yen could gain at the dollar's expense.

Even so, a dollar decline is not certain. A severe shock could still trigger a scramble for dollar funding, temporarily boosting the currency as happened in 2008 and in March 2020, but some investors see the dollar as a major market risk again as 2027 approaches.

In our earlier article on the mounting strains in the U.S. AI data-center buildout, we highlighted how rising financing costs, construction delays and power-grid constraints are making parts of the $10 trillion infrastructure pipeline look less credible. We also noted that setbacks at AI-linked infrastructure firms and cost overruns can pressure investor confidence and tighten funding conditions—risks that become more important as markets price in AI-driven growth and returns.

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