In the first half of 2025, the US dollar saw its steepest decline in over five decades. The DXY index—which tracks the dollar against major trading partners—fell about 11% from January to June, marking the end of a decade-long rally that began in 2010 and had delivered nearly 40% cumulative gains.

Since mid-year, the dollar has traded sideways as investors reassess the sustainability of the forces, particularly fiscal and external imbalances, that once underpinned its strength.

Year to date the US dollar has fallen 5.59% against the Australian dollar.

In our view, the US dollar remains overvalued, and its underlying fundamentals are beginning to weaken. Out of the 33 currencies we track in our valuation model, only nine screen as more expensive. In our view, the “free lunch” period for the dollar may be ending, with depreciation likely in the years ahead as US economic exceptionalism fades. Reduced foreign investment, hedging-related outflows, persistent debt pressures, and concerns about the Federal Reserve’s independence point to a more challenging environment for the greenback.

That said, the dollar remains deeply entrenched as the world’s reserve currency. Near-term challenges to its dominance could erode its safe haven appeal, but we view those risks as modest relative to the profound structural shift that would be required for the global economy to migrate to another primary reserve asset.

We examine five fundamental forces likely to shape the dollar’s future trajectory:

  • Internal balance: Mounting fiscal deficits and rising interest expenses.
  • External balance: Persistent current-account shortfalls and the US economy’s reliance on foreign capital inflows.
  • International status: Growing questions around the dollar’s safe haven appeal and reserve currency dominance.
  • Central Bank credibility: Political interference and renewed doubts over the Fed’s independence.
  • Geopolitical risks: Escalating tariff tensions, the US-China rivalry, and the ongoing conflict in Ukraine.

Internal balance

Despite strong US GDP growth in 2025, we expect activity to slow in the coming quarters. Stubborn inflation limits the scope for additional monetary easing, even after a prolonged period of high interest rates. At the same time, federal debt and interest costs are set to climb further, straining investor confidence in fiscal sustainability and putting long-term downward pressure on the dollar.

With no credible plan to balance the budget in place, the US debt/GDP ratio is likely to continue rising. One mitigating factor is that household and corporate debt service ratios remain below their long-term averages, offering some cushion against near-term financial strain. Still, the fiscal outlook is a growing vulnerability.

External balance

The United States’ account deficit as a share of GDP continues to widen, highlighting the economy’s reliance on foreign capital. This stands in contrast to countries like Germany and Japan, which maintain consistent surpluses. The US also carries a large negative net international investment position, underscoring its dependence on overseas financing.

Foreign investors currently hold about $18 trillion in US equities (roughly 20% of the market) and $7 trillion in Treasuries (about 25% of the market). Slower US growth, diminished equity market advantages, and rising fiscal concerns could reduce the appeal of US assets, weakening portfolio inflows or even sparking outflows. Recent FX moves already suggest that foreign equity reallocations are influencing currency performance, and a significant pool of US holdings remains exposed to rebalancing.

International status

The dollar continues to dominate global finance, but its supremacy looks more fragile than in the past. While its reserve currency role is not under immediate threat, diversification is underway. Central banks have steadily increased gold reserves, reflecting concerns about US fiscal sustainability and potential dollar depreciation.

Gold, however, cannot fully substitute for the dollar. It yields nothing and is impractical for global trade and financial transactions. Meanwhile, no viable alternative reserve currency exists. A gradual shift toward a multicurrency system is plausible, but it would unfold slowly. The dollar is still used in nine out of ten FX transactions, accounts for about half of global trade invoicing, represents nearly 60% of official reserves, and benefits from unmatched market depth and liquidity.

Historically, the dollar has served as a safe haven during equity selloffs. Its sharp April decline alongside equities was unusual, reflecting tariff risks, weaker confidence in US institutions, and liquidity-driven margin calls. Nonetheless, rising deficits, political polarization, and a leveraged financial system could reduce the dollar’s reliability in future crises.

Central Bank credibility

The Fed has shown determination in tackling inflation after it skyrocketed post-covid, raising rates aggressively and reducing its balance sheet by nearly $2 trillion without derailing the labor market. Currently, inflation expectations remain anchored, reinforcing the central bank’s credibility.

But political interference is an emerging risk. The Trump administration has pressured the Fed to cut rates more aggressively and even attempted to remove Fed Governor Lisa Cook—an unprecedented move that underscores the risk of weakened central bank independence. While institutional safeguards still protect the Fed’s autonomy, concerns about potential “fiscal dominance”—wherein monetary policy is bent toward sustaining government borrowing—could weigh on investor confidence in the dollar.

Geopolitical risks

Geopolitics has become a more important driver of US currency risk. Tariff announcements have already reshaped growth and inflation forecasts, with the US appearing especially exposed relative to other economies. The US–China rivalry remains the most important flashpoint, while Russia’s ongoing war in Ukraine continues to create uncertainty. The recent Trump-Putin meeting raised eyebrows, though prospects for dialogue may help ease tensions.

Still, any scenario that draws the US more directly into conflict would carry significant downside risk for the dollar, particularly if paired with weaker investor confidence in US institutions.

A strong currency, but growing cracks

The US dollar remains the bedrock of the global financial system, backed by unrivaled liquidity, deep capital markets, and widespread trust. But investors should not mistake resilience for invincibility. Valuations remain stretched, and the structural supports that have long underpinned US economic and financial dominance are eroding.

In the years ahead, we expect the dollar to gradually depreciate as fiscal strains mount, growth momentum slows, and diversification accelerates. That does not mean the dollar will lose its reserve status anytime soon, but it does suggest investors should prepare for a world where the greenback is a little less exceptional, in which returns from hedged US exposure for foreign investors and unhedged foreign exposure for US investors could play a more important role in portfolios.

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