After a 14-year US dollar bull run, we believe the dollar’s path has turned definitively and its descent will continue.

At the beginning of 2025, on a real effective exchange rate basis the US dollar reached its highest level since 1985, making it one of the most expensive currencies globally (Exhibit 1). In our view, the dollar’s strength resulted from the US’s ‘exceptionalism’ in economic growth, its strong stock market performance and its real yield advantage. Underlying these attractions was firm faith in the institutional framework that safeguards those holding US assets and the dollar.

Some of these foundations that underpinned the dollar’s strength are now shifting. As a result, we expect the dollar to continue to weaken gradually, although some scenarios could lead to more disorderly moves.

The role of exceptionalism in US dollar strength

To understand where the dollar is going next, it is worth picking apart the drivers of its prior strength. Exhibit 2 captures how multiple trends have combined to form a virtuous dollar cycle. It is important to consider all of these factors together, given the numerous interconnections at play. Too often, individual components are spoken about as if they are exogenous, but the dollar’s strength – or weakness – is the by-product of all of these trends and their interplay.

Given the dollar cycle is a cycle, there is no obvious one place to start, but most commentators begin with the US’s growth outperformance. The US economy has generally outperformed other major economies, such as the eurozone and Japan, since the financial crisis. The shale revolution moved the US closer to energy independence, making its economy less vulnerable to energy shocks such as that which occurred following the war in Ukraine.

Not only was the broad US economy performing better, but so were the technology companies, which thrived thanks to new innovations such as (most recently) artificial intelligence. Many of these companies were established in the US and have contributed to the significant outperformance of US equity benchmarks.

Relatively stronger US economic activity allowed the Federal Reserve to maintain higher interest rates than its G7 counterparts. Europe, in the aftermath of the sovereign crisis, and Japan, trapped in a deflationary regime, even had to dabble with negative interest rates.

Adding to the attractiveness of US assets was a widespread confidence in the dollar as a store of capital, thanks to the backing of a strong institutional architecture including political transparency, the rule of law, and a credible independent central bank with a clear price stability mandate to underpin the value of the dollar. This institutional support provided global investors with the confidence to hold dollar assets in normal times, and to seek refuge in dollar assets during periods of global uncertainty, such as geopolitical tensions, economic crises or market volatility.

Growth outperformance, higher interest rates, and strong institutions attracted global capital to the US, providing a pool of capital that funded loans to US households, firms and the US government. This capital allowed higher spending, further fuelling domestic growth, as well as supporting demand for goods and services sourced from elsewhere in the world.

Successive US governments took full advantage of this available capital. US government debt has risen dramatically relative to the eurozone over the last decade, for example (see Exhibit 3). The fact that US fiscal policy was so stimulative is an underappreciated driver of the US’s exceptional economic growth.

The importance of US demand to global trade meant that governments around the world, particularly in emerging economies, needed to hold dollars to facilitate trade flows in the event of crises or volatility. As a result, the US dollar became the world’s reserve currency. 

More capital thus flowed into the US, fuelling further US growth outperformance, and the cycle continued. Years of consecutive capital account surpluses (money flowing into the US from overseas) to fund current account deficits (US spending flowing out to purchase goods and services – see Exhibit 4) has resulted in the rest of the world being very ‘long’ US assets (Exhibit 5).

Where now for the US dollar?

With dollar asset valuations already stretched, the virtuous dollar cycle has now stalled in several places. President Trump’s goal to bring manufacturing production back to the US has also played a central role in the dollar’s recent decline. The President’s desire to revive the US’s manufacturing base is understandable, given the livelihoods and regions that have been upended by its demise. But our flow chart (see Exhibit 6) provides a useful framework for thinking through some of the challenges and implications of this ambition, and the impact such a policy must have on the dollar.

Imports have allowed the US to consume more than it is able to produce. In the short term, at least, curbing imports must by definition coincide with a reduction in US consumption of goods and services, whether that fall in consumption is from households, businesses or the government. Proponents of tariffs would argue that this recalibration will just cut US spending on overseas goods and services, but that is unrealistic given the key role of imports in US production.

Instead, falling imports should be expected to reduce US economic growth, lower US interest rates and reduce the attractiveness of US assets, which would in turn lead to a weaker dollar.

The fall in US demand for overseas goods and services will force countries that have relied on this US demand to either accept lower growth, or to stimulate their economies. China and Germany in particular have relied excessively on US demand. Both are reacting with domestic stimulus, with the shift in Germany’s fiscal policy especially noteworthy. This stimulus must, again by definition, mean that these countries will deploy more of their capital at home rather than sending it to the US. And Japan, the largest foreign holder of US Treasuries, is another important driver of the dollar outlook. As the Japanese economy begins to reflate, local bond yields are rising and enticing more capital to stay at home.

Our core scenario is that a moderate imposition of US tariffs will lead to a new trade, capital and dollar cycle. We expect this shift to be relatively orderly, leading to ongoing gradual dollar declines. But there are more disorderly scenarios that investors should be mindful of, even if we still see these events as low probability outcomes.

Chief among these potential disorderly scenarios would be a strict follow-through on tariffs, in line with those announced on ‘Liberation Day’. Such a development could disrupt the dollar cycle more meaningfully, given it would likely lead to a sharper slowdown in growth, particularly in the US.

Importantly, as the diagram in Exhibit 6 makes clear, any efforts by the US government to cut taxes to offset the economic blow of high tariffs would mean trying to borrow more from a world that is less willing to lend. We could once again see bond yields rise at the same time as the dollar falls, as we did briefly in April.

We would also be concerned by any signs of damage to the architectural infrastructure that underpins US growth and the attractiveness of holding US assets. Threats to the independence of the Federal Reserve are top of mind here, but also the creeping risk that cryptocurrencies could become fungible functioning currencies in parallel to the dollar. Any proposal to encourage foreign Treasury owners into ultra-long maturity zero coupon debt, in exchange for trade or defence agreements, could also prompt a more disorderly dollar move.

As the path of the US dollar takes a new direction, investors should think carefully about their currency exposures, particularly given that US dollar exposure has increased significantly in several global benchmarks over recent years. Reducing dollar exposure via portfolio currency overlays, or adding currency-hedged strategies, could help to mitigate some of this dollar risk.