The strong dollar cycle likely peaked in January 2025, and signs of weakening are becoming increasingly evident.
The dollar appears to be under significant pressure, both in the near term and within the broader context of global investors’ strategic asset allocations. While we do not foresee the dollar losing its status as the primary reserve currency in the foreseeable future, the case for global diversification has never been stronger. Asset classes outside the US including non-US equities, European fixed income, and emerging market debt may benefit from ongoing pressures on the USD.
The Tactical View: Near-Term Risks for the USD
The current macroeconomic and market environment suggests further downside risks for the USD. US growth fundamentals point to a slowdown, magnified by uncertainty surrounding recent policy measures such as the immigration freeze and trade tariffs. While we do not anticipate a US recession, the outlook indicates a deceleration, contrasting with growth recovery in regions like the eurozone. This divergence in growth prospects is a key negative driver for the USD.
Relative interest rates also paint a bearish picture for the dollar. The US Federal Reserve is expected to lower its policy rate more aggressively than its counterparts. In contrast, the European Central Bank appears near the end of its easing cycle, and the Bank of Japan may consider further tightening. This divergence compresses the interest rate differential between the US and its peers, exerting additional downward pressure on the USD.
The US policy backdrop further amplifies risks for the dollar. Concerns over excessive fiscal spending could undermine global appetite for USD-denominated assets, potentially driving long-end rates higher and triggering corrections in US fixed income and equities. Additionally, political pressure on the Federal Reserve threatens central bank independence, a cornerstone of credible macroeconomic policy.
The dollar’s safe-haven status has also eroded. Recent market episodes, such as the escalation of the trade war and disappointing US labor market data, have seen the dollar behaving more like a risk-on currency, weakening alongside US equities rather than benefiting from risk aversion.
The Strategic View: Overvaluation and Investor Behavior
From a valuation perspective, the dollar is overvalued by at least 10% according to most metrics. The Fed’s real dollar index, for instance, is 13% above its long-term average.1 The strong dollar cycle likely peaked in January 2025, and signs of weakening are becoming increasingly evident.
This overvaluation, coupled with shifting fundamentals, is influencing global investor behavior. Tactical indicators, such as value and carry factors, are not supportive of near-term USD appreciation. Furthermore, technical factors reveal that shorting the USD is currently among the most crowded trades. While this positioning could create temporary volatility or even a brief rebound, we believe unsupportive macro fundamentals will prevail as the dominant driver.
The Structural View: The Role of the USD as a Reserve Currency
In the longer term, the dollar remains entrenched as the world’s primary reserve currency. While its share of global reserves has declined from 70% two decades ago2 to 58% today3, no serious competitor has emerged. The euro, at 20% of reserves, and the yen, at 5.8%, remain far behind.4 The sheer size and liquidity of the US Treasury market, more than ten times the size of the German bund market5 and 30 times as liquid, ensure that the dollar and US Treasuries remain critical global investment vehicles.
Although the dollar’s share of reserves may continue to gradually decline, this process is expected to be slow and orderly.
Investment Implications: The Case for Global Diversification
The challenging outlook for the USD reinforces the need for global diversification. For years, global investors have been over-allocated to US assets, driven by perceptions of US exceptionalism. However, that narrative is now under pressure, creating opportunities for rotation into non-US equities, European fixed income, and emerging market debt.
Emerging market (EM) local currency debt stands out as particularly well-positioned. The J.P. Morgan GBI-EM Diversified Index, for example, spans 19 countries across Asia, EMEA, and Latin America, offering substantial geographic diversification. Local macroeconomic factors, such as central bank policy and domestic inflation, often have a significant influence on EM market performance, adding an additional layer of opportunity.
In conclusion, while the dollar is unlikely to lose its reserve currency status, its overvaluation and the shifting macroeconomic environment present challenges for USD-denominated assets. This underscores the importance of global diversification as investors seek to capitalize on opportunities beyond the US.
Benoit Anne is a Senior Managing Director and the Head of Market Insights at MFS Investment Management.
The author’s comments, opinions and analysis are for general informational. purposes only and should not be considered investment advice or a recommendation to invest in any security or to adopt any investment strategy. This material has been prepared without taking into account any personal objectives, financial situation or needs of any specific person. Comments, opinions and analysis are rendered as of the date given and may change without notice due to market conditions and other factors. This material is not intended as a complete analysis of every material fact regarding any market, industry, investment or strategy. No forecasts can be guaranteed.
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Sources:
1 Datastream, Fed. Monthly data for the Fed broad trade weighted index. Up to Aug 2025. Daily data for MFS quant model, up to 12 Sept. 2025.
2 IMF, Cofer dataset. Quarterly data up to March 2025
3 IMF, IMF data brief: Currency Composition of Official Foreign Exchange Reserves, 17 July 2025
4 IMF, Cofer dataset. Quarterly data up to March 2025
5 Bundesrepublik Deutschland ‒ Finanzagentur GmbH, outstanding volume 31 August 2025 - €1.949 trillion
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