The reasons for the fall of the US dollar include weak economic growth prospects, interest differential decline, investor sentiment towards US-based investments, geopolitical changes, and less inflow of capital from abroad.
U.S. assets have been at the epicenter of global market volatility year-to-date.
In a rare and striking shift, U.S. stocks, bonds, and the drop in US dollar have all declined altogether. This haze of weakness isn’t just unusual; it signals a meaningful shift in sentiment.
The driver of the drop in US dollar? A sharp rise in U.S. policy uncertainty has shaken investor confidence in U.S. assets and even sparked debate about the U.S. dollar’s role as the world’s primary reserve currency, but what’s next for the drop in US dollar?
Here in this blog of ForexDrift, we will examine the pillars of U.S. exceptionalism, consider how they might be shifting, and discuss how the shifts might impact your own investment decision-making and the drop in US dollar.
For decades, U.S. exceptionalism has been a cornerstone of global investing, powered by robust economic growth, tech dominance, high real (inflation-adjusted) yields, and deep markets. Since the early 2010s, U.S. stocks have consistently outperformed, Treasuries have attracted steady demand, and the dollar has risen almost uninterruptedly. In turn, many global investors have built up sizeable allocations to U.S. assets. These capital inflows have more than offset large U.S. trade deficits, underscoring the supremacy of “King Dollar” and pushing it to stretched valuations by many measures. The concept of the US dollar is dropping didn’t exist.
The tide may be turning, aka US dollar is dropping. For the first time in years, the dollar looks to be unwinding its longstanding overvaluation, which could mean a 10%–20% decline over the medium term against major peers such as the euro and Japanese yen. Our two preferred long-term valuation models, the dollar’s real effective exchange rate versus long-term averages, and one based on purchasing power parity, both point to a similar magnitude.
J.P. Morgan Asset Management’s 2025 Long-Term Capital Market Assumptions estimate EUR/USD rising to 1.29 and USD/JPY falling to 114 over a 10-15 year investment horizon. Their base case is that the dollar loses a few more percentage points by the end of this year against major peers, but the risk is that medium-term weakness will occur more swiftly.
The dollar influences every aspect of investment strategy, from the economic outlook to return expectations, to valuations, earnings models, and, more directly, currency risk.
A weaker dollar can make imports and dollar-priced commodities more expensive, potentially fueling inflation and complicating Federal Reserve (Fed) policy. At the same time, it boosts overseas revenues for U.S. multinationalS, unless tariffs or supply chain issues squeeze profit margins. Either way, the dollar’s direction carries consequences.
For global investors, this calls for a reset. U.S. assets have been the default destination for over a decade, with the dollar as a reliable anchor. In turn, foreign ownership of U.S. assets has climbed to $26 trillion.
As a result, even small shifts in portfolio allocations or hedging decisions can create big waves. For example, over the last few years, we’ve seen foreign investors cut back on currency-hedging their U.S. equity exposures. Euro-based funds currently FX-hedge only 50% of their U.S. stock holdings, down from a long-term average of 67%. Indicatively, with $16 trillion in foreign-held U.S. stocks, just a 1% change in hedging could lead to over $160 billion in U.S. dollar selling.
Momentum seems to be heading in that direction. Foreign investors were still pouring an average of about $7 billion per week into U.S. stocks through early March. But in the past two months, those flows have collapsed to zero, with two of those weeks registering the biggest weekly outflows on record. At the same time, European stocks are seeing renewed attention, with inflows in seven of the last 10 weeks rivaling the strongest months over the last two years.
We don’t think investors need to overhaul their asset allocations, and the United States remains a valuable core holding. But high uncertainty and the potential for the US dollar is dropping indicates that ignoring geographic imbalances carries a greater risk than it once did. In a shifting environment, purposeful portfolio positioning, including international assets and gold, is crucial.
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Heading onwards, the dollar had appreciated by over 50% from its Global Financial Crisis (GFC) lows, one of the longest periods of dollar strength since the 1970s. To gauge the potential for a new dollar regime, we can first examine the interconnected pillars that have upheld the dollar’s strength. Each is facing its own stress test.
According to the assessment, ranked from most to least under threat.
U.S. Dollar (DXY) Index, Red = weak USD cycle, Green = strong USD cycle
In the latest debates regarding what is causing the US dollar to drop, geopolitical reasons were discussed along with economic factors. One of the questions is whether countries such as Iran move towards decreasing the use of dollars. As a result, headlines emerge about “did Iran drop the US dollar” or even “Iran drops US dollar.” In reality, this is one of the measures taken by countries that are being sanctioned or have any political ties, and have started replacing dollars in international transactions with other currencies or even bartering. Countries such as China, Russia, Venezuela, North Korea, etc., have been doing it for quite some time now.
Though it sounds impressive to read something such as “did Iran drop the US dollar,” it doesn’t explain the present-day weakening of the dollar, and why is the US dollar dropping. It is still influenced by macroeconomic factors. However, at the same time, it cannot be denied that geopolitics also plays a certain role in affecting the dollar’s situation. While each country alone does not play a decisive role, when some countries are taking similar steps, then they start adding to the story that the global economy may be undergoing a slow process of divesting itself of the dominant dollar.
The U.S. economy has consistently outperformed its developed market peers, particularly during the post-GFC and post-COVID recoveries. This growth edge was paired with higher yields, buoyed by a Fed that raised rates earlier and more aggressively in 2022–23. Together, that attracted capital to U.S. stocks and bonds.
This year has started on a more somber note. Tariffs are expected to hit the U.S. economy harder than the rest of the world, prompting Wall Street economists to raise their recession probability forecasts from roughly 20% to 45%. Meanwhile, the Fed is moving toward rate cuts alongside other central banks, narrowing the yield differential that has supported dollar strength.
This pillar is weakening. A dampening U.S. growth premium and shrinking yield advantage make the United States look relatively less attractive to foreign capital. More or less it’s directed to drop in US dollar.
That said, the dollar has weakened more than interest rate differentials alone would suggest, a sign that sentiment and flows are playing significant roles in the current environment. The U.S. Dollar Index is currently 5% discounted relative to its yield-implied fair value.
But in a break from the pattern, it’s happened repeatedly this year. The drop in US dollar happened on the same days that U.S. stocks and bonds have sold off, signaling that the “confidence premium” in U.S. assets has been in question.
For Euro-based investors in unhedged U.S. stocks, the impact has been acute: An investment linked to the S&P 500 would be down roughly 16% compared to “just” about 8% for U.S. investors, a meaningful divergence from prior drawdowns, and renewed incentive for foreign investors to revisit currency-hedging for overall asset allocations.
U.S. assets still command respect, but confidence doesn’t seem as automatic.
The United States has led the AI boom, hosting over 75% of globally listed large and mid-cap tech companies. The Magnificent 7 have been key players, now making up about 30% of the S&P 500’s market cap and over 10% of the global stock market. The overall assumption is that dynamism for the U.S. economy is in question.
Yet, China’s DeepSeek AI model, revealed earlier this year, served as a challenge to U.S. dominance. In addition, major U.S. tech firms face antitrust risks, and innovation hubs in Japan, India, and elsewhere are gaining appeal.
This pillar remains strong, but it’s slightly vulnerable.
Stable institutions, an independent central bank, and a trusted legal framework underpin the dollar’s role as the cornerstone of the global financial system. Even amid political gridlock and polarization, global investors have relied on America’s consistency and institutional continuity.
Some argue that trust is now being tested. Recent policy shifts have brought real political volatility, from tariff threats to public challenges against the Fed. Even before this year, the increasing use of financial sanctions and dollar-based enforcement tools began to erode the perception of the U.S. dollar as neutral ground. In 2022, Russia’s foreign exchange reserves were frozen, and in early 2025, a single tweet threatened sanctions on Colombia’s dollar assets.
Dollar access may not be guaranteed, and U.S. security guarantees may come with conditions.
At the same time, the U.S. fiscal picture continues to deteriorate. Deficits are widening, interest costs are rising, and there’s little political consensus on restoring stability. However, we continue to see consistent demand at U.S. Treasury auctions, suggesting these issues are a less acute driver of recent dollar moves.
This pillar remains solid, but it’s becoming shakier as political risk grows more structural than episodic.
The dollar has dominated global financial market activity partly because it’s been the only real option. No currency rivals its global role in reserves, trade settlement, or financial infrastructure. It accounts for about 90% of FX transactions, 66% of international debt, 58% of foreign exchange reserves, and 48% of SWIFT transactions.
The euro, the closest competitor, lags the dollar by over 50% in FX transactions. While digital finance could narrow the dollar’s lead, alternative currencies have been more volatile this year. Initiatives such as the BIS’s Project mBridge, exploring alternative central bank payment systems, could eventually challenge the dollar’s dominance, but they’re still in early stages.
This pillar remains strong, with only slight fraying at the edges.
How you diversify across currencies depends on your home base and your risk appetite.
We continue to see U.S. assets as critical, core allocations to portfolios. But some pivot back toward more globally diversified portfolios may play out in the year ahead.
One straightforward approach to position for this potential scenario: shift some of your investments into international markets that aren’t denominated in U.S. dollars, focusing on deep and liquid markets such as Europe and Japan. This can help reduce currency risk and further diversify sources of return in your portfolio.
Another option is a currency overlay strategy. This involves making specific currency trades against the dollar, investing in alternatives such as the euro, Japanese yen, and gold to spread out your currency exposure. Using FX forward contracts may be a cost-effective way to do this, offering flexibility and allowing you to tailor your strategy to your financial goals.
If you’re outside the United States, consider hedging strategies to shield your investments from dollar fluctuations. Forward contracts can help you hedge your exposure back to your home currency while maintaining your current investments. For those with managed portfolios, investing in hedged share classes can also help manage currency risk without altering your overall investment strategy.
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