US Market: AI boom could weaken dollar’s safe-haven appeal as foreign flows rise

A sustained decline in US equities could prompt investors to reduce their exposure to American assets, potentially offsetting demand for the greenback during periods of market stress.Read more: Global Market: South Korean shares surge 6% as SK Hynix earnings fuel AI chip rallyDominic Bunning, head of G10 foreign exchange strategy at Nomura, said the dollar's response to an unwinding of the AI trade was becoming less predictable than in previous market downturns.Live EventsForeign exchange flows signal potential vulnerabilityRecent market movements have offered an early indication of the changing dynamics.

When AI valuations came under pressure last week, investors seeking safety favoured the Japanese yen and Swiss franc over the dollar. The greenback posted modest gains against the euro, largely because concerns over civil unrest in France weighed on the single currency, according to Reuters.Kevin Ford, lead foreign exchange and macro strategist at Convera, said the relationship between the AI trade and the dollar had become increasingly apparent whenever investors questioned technology valuations.Read more: Global Market Today: Asian stocks advance on resurgent AI optimismForeign inflows into US equities have reached record levels, while foreign direct investment has lagged.

This suggests that a significant portion of overseas capital comes from institutional investors who can quickly adjust allocations in response to changes in growth expectations, interest rates and technology valuations.Erik Nelson, global head of foreign exchange strategy at Wells Fargo, has compared these investments with the short-term capital flows often associated with emerging markets.The AI boom has strengthened expectations of faster US economic growth, persistent inflationary pressures and higher interest rates, helping lift both the dollar and Treasury yields.

Noah Buffam, a foreign exchange strategist at CIBC Capital Markets, said the repricing of US interest rates driven by the AI trade had contributed to the dollar's appreciation.A reversal could expose the currency to pressure through three channels: weaker economic growth, a reduced interest-rate advantage and declining foreign demand for US stocks and corporate debt.If AI investment disappoints, companies could scale back spending, slowing domestic economic activity.

A weaker growth outlook could also prompt the Federal Reserve to cut interest rates, eroding the dollar's yield advantage over other currencies.However, the adjustment may not happen immediately. Investors have continued buying market dips, suggesting that any sustained decline in the dollar could develop over several months or even years.Dotcom crash offers lessons for the dollarThe experience of the dotcom bust in the early 2000s suggests that a sharp decline in technology stocks would not automatically lead to an immediate dollar selloff.Reuters reported that the dollar remained relatively firm for nearly two years after the Nasdaq peaked in March 2000.

It weakened later as stress spread through US credit markets following corporate failures, including WorldCom, alongside other developments such as a recovery in global economic growth.The current AI investment cycle, however, has a stronger US concentration. Nelson noted that the real trade-weighted dollar had remained above its long-term average, measured from 1973, for 12 consecutive years, the longest such period on record.Foreign investment is also more heavily concentrated in equities and corporate bonds than it was around the turn of the century, while foreign direct investment has been comparatively weaker.

This could leave the dollar more exposed if international investors reassess their commitment to US assets.A failure of AI infrastructure investments to generate sufficient returns could widen credit spreads and force companies to reduce capital expenditure. The resulting slowdown could affect demand for industrial equipment, computer hardware and energy, spreading the impact beyond technology stocks.Credit-market concerns are already emerging around riskier parts of the AI ecosystem.

Reuters reported that credit default swap spreads for heavily indebted neocloud companies, including CoreWeave, had widened sharply in recent weeks, adding to pressure on equities.Shaun Osborne, chief foreign exchange strategist at Scotiabank, pointed to movements in credit default swaps as a sign of growing stress around the edges of the AI investment boom.The US fiscal position could further complicate the outlook.

Unlike the budget surplus recorded near the 2000 technology peak, Washington now faces a substantial fiscal deficit, potentially limiting its ability to provide counter-cyclical stimulus without unsettling government debt markets.Dollar could initially strengthen during a crisisThe decisive factor for currency markets may not be a decline in technology shares alone, but whether the resulting turmoil develops into a broader US-specific credit and economic slowdown that changes expectations for Federal Reserve policy.In such a scenario, the Japanese yen could gain against the dollar as investors reassess the relative outlook for the two economies and the direction of interest rates.Nevertheless, a dollar decline is not inevitable.

A severe financial shock could initially strengthen the currency if investors rush to secure dollar funding to meet liabilities denominated in the US currency.That dynamic was evident during the 2008 global financial crisis and in March 2020, when demand for dollar liquidity surged. Such a rally, however, could prove temporary if the underlying stress subsequently weakens US growth prospects and demand for American assets.The dollar has again emerged as a significant risk factor for global investors, particularly following the sharp market disruption triggered by US President Donald Trump's announcement of sweeping tariffs in April 2025.Nelson said investors' sensitivity to a substantial repricing or selloff in the dollar was considerable, adding that the currency's vulnerability would be worth monitoring as markets head into 2027.The central risk is that the AI boom, which has helped support US asset valuations, economic optimism and the dollar, could eventually become a source of instability.

If foreign investors begin withdrawing capital from US markets during a downturn, the dollar's traditional safe-haven appeal may no longer be sufficient to offset the selling pressure.(Disclaimer: This article is based on inputs from agencies. These do not represent the views of The Economic Times.)(You can now subscribe to our ETMarkets WhatsApp channel)