Gold and Bitcoin have weakened collectively, while the US dollar has staged a strong counterattack, indicating the unraveling of the 'devaluation trade' that has captivated markets for the past two years.

The source of this shift can be traced back to January 30th, when US President Donald Trump nominated Kevin Warsh for the position of Federal Reserve Chair.

Warsh's nomination prompted investors to reassess the popular macro strategy centered on diversification and reducing dependence on the US dollar.

On that day, the price of gold plunged 13% from its record high, marking its largest decline in over forty years, and Bitcoin subsequently experienced a sharp sell-off.

The US dollar, after a prolonged downtrend, found a bottom and rebounded.

Although Warsh gained Trump's favor by advocating for lower interest rates, his previous hawkish stance left a strong impression on many investors.

This contradictory label left investors uncertain about his future policy direction, leading some to adopt hedging strategies following the announcement of his nomination.

Market developments intensified last week.

Presiding over his first interest rate meeting as Fed Chair, Warsh emphasized that price stability is the paramount objective.

This statement alleviated market concerns, as investors had previously worried that Warsh might yield to the White House's demands for rate cuts.

Gavyn Davies, co-founder and chairman of Fulcrum Asset Management and former chief economist at Goldman Sachs, stated, "Anyone who thought Warsh would be a puppet installed at the Fed to cut rates regardless of inflation will be sorely disappointed. He is not that style of Fed Chair."

Since Warsh's nomination as Fed Chair, the 'devaluation trade' has been receding.

This strategy involves increasing holdings in assets like gold and Bitcoin to avoid currencies perceived as vulnerable to excessive inflation, fiscal, and monetary policy impacts, such as the US dollar.

This narrative was one of the dominant themes in markets over the past two years.

Explosive growth in US government borrowing, coupled with inflation exceeding the policy target for five and a half consecutive years, heightened concerns about the erosion of the dollar's purchasing power.

"The concerns were about the inflation target, the Fed's credibility, and its independence," said Jonathan Owen, a portfolio manager at TwentyFour Asset Management. "I think those concerns have largely been alleviated."

Currently, traders are fully pricing in two Fed rate hikes by the first quarter of 2027, whereas before last week's meeting, the market anticipated only one hike.

Warsh's remarks have further boosted the US dollar and lifted prices of inflation-sensitive long-term US Treasuries, while gold and cryptocurrencies have come under pressure.

The dollar had already benefited from a resurgence of confidence in American exceptionalism.

Massive investments related to artificial intelligence and the US's relatively favorable energy position have enhanced the dollar's appeal compared to the currencies of energy-importing nations in Europe and Asia.

A stable US jobs market has also provided support for the dollar.

Following last week's meeting, JPMorgan raised its forecasts for the dollar against the euro and recommended going long on the dollar against a basket of low-yielding currencies, including the Swiss franc and the New Zealand dollar.

Meera Chandan, co-head of global foreign exchange strategy at JPMorgan, stated plainly, "As long as the Fed maintains a tightening bias, the logic for the devaluation trade is largely broken."

In the currency options market, demand for hedging against further dollar appreciation relative to traditional safe-haven currencies like the Swiss franc has climbed to its highest level since 2022.

Warsh has pledged to restore the Fed's inflation-fighting credibility while also calling for a 'policy paradigm shift,' advocating a comprehensive overhaul of the Fed's policy-making, communication mechanisms, and balance sheet management framework.

This new rhetoric has pushed the inflation-adjusted yield on the 10-year US Treasury to 2.28%, a new high in over a year.

The Glow Fades for Gold

Rising real yields increase the opportunity cost of holding non-yielding assets like gold and Bitcoin, suppressing their price performance.

As the market grows more cautious about US monetary policy prospects, physical investment demand for gold is also shrinking.

Deutsche Bank has significantly lowered its gold price forecast by as much as 22%.

Similarly, Goldman Sachs last week reduced its year-end gold price forecast by $500 to $4,900 per ounce.

So far this month, net outflows from the world's largest gold ETF, the SPDR Gold ETF, have approached $1 billion.

Cumulative outflows from the fund since late February have reached $12 billion, marking the largest four-month withdrawal since 2013.

Investors Withdraw from Largest Gold ETF

Of course, the underlying logic of the devaluation trade is not solely based on monetary policy.

Concerns about government borrowing and debt sustainability persist.

Although US Treasury Secretary Scott Besant has pledged to halve the budget deficit by the end of Trump's term, the current US budget deficit remains near 6% of GDP.

In the UK, investors similarly worry that continued government borrowing to fund spending will further strain already fragile public finances.

Japanese government spending also remains a concern for investors.

These factors collectively drove a surge of over 175% in the gold price in the two years leading up to January this year, also spurring demand for alternative value reserve assets.

Such safe-haven buying could potentially resurface in the future.

Billionaires Ray Dalio and Ken Griffin believe gold may ultimately prove safer than the US dollar, warning that the trajectory of US debt could trigger a future fiscal crisis.

Paresh Upadhyaya, a Vanguard investment strategist, has now turned bullish on the dollar, analyzing, "The devaluation trade is a medium-to-long-term structural theme, but for now, cyclical factors will overwhelm the devaluation narrative."

For the moment, investors appear more focused on the Fed's policy stance towards controlling inflation.

JPMorgan estimates that investor allocations to the devaluation trade (primarily gold and Bitcoin) have retreated to levels seen in March 2025, a time before Trump's tariff policies rekindled concerns about inflation and policy credibility.

JPMorgan's Chandan stated, "The devaluation trade is slowly dying."