AI worries expose dollar’s hot-money problem

The US dollar has long been viewed as a safe haven during market downturns, but rising investments in AI and related sectors may weaken its role. Foreign capital has been flowing into US mega-cap equities, hyperscaler corporate bonds, and power-grid infrastructure, making the dollar an increasingly popular bet on American growth and higher yields.

However, if the AI narrative falters, the dollar's safe-haven status could clash with its growing role as a risk-sensitive asset held by sensitive investors. A downturn in stocks could prompt investors to sell US assets, potentially overwhelming the safe-haven demand for the currency. Nomura's Dominic Bunning warns that if the AI trade unravels, the dollar's safe-haven benefits may not be as clear-cut as before.

Foreign flows into US equities are at record levels, while foreign direct investment has lagged. This capital influx comes primarily from institutional allocators who may adjust their positions based on reassessments of US growth, interest rates, or tech valuations. The AI boom has fueled expectations of stronger US growth, higher inflation, and rising rates, which in turn have lifted the dollar alongside Treasury yields.

If AI-related returns fall short, the dollar could face vulnerabilities on multiple fronts. A weaker economic outlook could force the Federal Reserve to lower rates, diminishing the dollar's yield advantage. Reduced domestic investment could undermine the exceptionalism narrative. Diminishing institutional demand for US equities and bonds would also weaken a crucial source of structural support.

So far, investors have been willing to purchase dips, suggesting that any sustained weakness could unfold over months or years. However, the AI buildout is more US-centric, and the trade-weighted dollar has stayed above its long-run average since 1973, the longest streak on record. Foreign inflows are also more concentrated in equities and corporate bonds than in 2000, while foreign direct investment is weaker.

If AI-related investments fail to yield results, credit spreads could widen, compelling AI companies to curtail capital spending, which could reverberate through the economy and dampen demand for industrial equipment, hardware, and energy. Worries about riskier elements of the AI sector, such as heavily indebted neocloud firms like CoreWeave, have already caused credit default swap spreads to rise sharply, adding pressure on stocks.

The real test, according to Wells Fargo's Erik Nelson, will be whether the stress becomes a US-specific credit and growth problem that could alter expectations for Federal Reserve policy. In that case, the yen might benefit from the dollar's decline, potentially causing a ripple effect in markets that are already under pressure.

While a dollar decline is not a certainty, it is a vulnerability worth monitoring as we move into 2027.