In the short term, heading into the summer, we can expect the greenback to rebound after its steep sell-off in April. But currency trends typically unfold over much longer time frames. In the longer term, watch for a weaker US dollar in the next few years, providing opportunities to add alpha through currency positioning.
Unlike high-quality government bonds, the US dollar is not an asset class. It is a currency that lies at the intersection of multiple powerful forces that tie together global financial, commodity, and trade markets. These interact to form complex dynamics that differ from the typical drivers of an asset class. We can see some of these at play today, shaping the longer-term direction of the currency.
Despite the US dollar’s bounce in May, I believe in the narrative that US exceptionalism is probably past its peak. I would actually argue that the beginning of the end came when western countries used financial sanctions on Russia and restricted access to the US dollar-based international payments system in response to Russia’s move into Ukraine. If you create limitations and questions around the reserve currency, the world will look for alternatives. Factors working against the US dollar:
Lagging US economy
Germany’s landmark fiscal expansion looks set to boost the eurozone economy, and China is slowly increasing its monetary and fiscal stimulus to help battle the negative effects of US tariffs. The US economy looks likely to lag these markets, reducing demand for dollars. The US productivity boom – underpinned by the massive increase in shale oil and gas production as well as leading edge in artificial intelligence – arguably has flattened out (for now!).
Deteriorating quality of US institutions
The quality of a country’s or region’s institutions, measured by factors like the strength of the rule of law, the level of central bank independence, and the integrity of the crucial innovation engine of a country’s educational establishments, is another driver of currency demand. The currency of a country with well-defined and enforced laws, along with a central bank that is insulated from political demands, would tend to draw inflows. After all, would you want to hold a currency that a central bank under pressure to cut rates would devalue by stoking inflation? While I do not think that this type of outcome is currently likely in the US, investors will be closely monitoring Federal Reserve independence and perceptions of political influence.
Diminishing attractiveness for global intellectual capital
A country’s ability to attract entrepreneurial, leading-edge thinkers is another long-term factor in currency demand. US businesses at the forefront of technological change – like the ‘Magnificent Seven’ stocks that drove the US equity market higher for years – draw foreign investment and demand for US dollars. The Trump administration’s policies could reduce the attractiveness of the US as a destination for immigrants who are global thought leaders.
On the flip side of the coin, a range of factors continue to support the US dollar. Interest rate differentials can drive exchange rates. With all else equal, more funds will flow into a country with higher interest rates than one with lower rates, boosting the higher-yielding currency. Factors working in favour of the US dollar:
US yield advantage
Looking at nominal US yields versus other global high-quality government bond rates, the US has an advantage. In early June, the 10-year US treasury note yielded about 4.44%, far more than the 2.53% offered by Germany’s 10-year government bond. Adjusting for inflation lowers the available yield – the US 10-year treasury inflation-protected securities (TIPS) yielded only 2.09% in early June – but that was still meaningfully higher than the real German yield. With the US experiencing more inflationary pressure than Europe, the Fed is less likely to cut rates, providing more interest rate differential support.
Ongoing front-loading of US imports from China
I expect front-loading of US demand for Chinese imports to continue after the two countries in early May announced a 90-day pause in higher tariffs. This would extend – and likely temporarily strengthen – the flow of US dollars into China, which the country would then need to recycle back into US assets.
How will the dynamics of the negative and positive drivers play out? I expect the positive factors will start to dissipate over the next few months. In the second half of 2025, the longer-term negatives weighing on the US dollar will likely take precedence, initiating a structurally negative trend for the greenback that could last for years.
As the US dollar’s downturn during the April sell-off in risk assets demonstrated, investors are no longer viewing the dollar as a safe haven during widespread market turbulence. This is a symptom of the longer-term negative factors for the greenback. The recent positive correlation between the US dollar and risk assets is a vital consideration for portfolio construction and diversification.
By Arif Husain, head of fixed income at T. Rowe Price
