After a 14-year US dollar bull run, we believe the dollar’s path has definitively turned. Since the start of 2025, the currency has been sliding against its major trading partners and we think its descent has further to go.

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 have shifted. 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 1 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 discussed 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.

Not only was the broad US economy performing better, but so were US technology companies, which thrived thanks to new innovations such as artificial intelligence. Many of these companies 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 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.

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 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 (see Exhibit 2). The fact that US fiscal policy has been so stimulative is an underappreciated driver of the US’s exceptional economic growth.

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 resulted in the rest of the world being very ‘long’ US assets (Exhibit 3).

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 played a central role in the dollar’s recent decline. 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.

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 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. 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.

In our core scenario, we expect this shift in international capital flows to be relatively orderly, leading to ongoing gradual dollar declines. However, there are more disorderly scenarios that investors should be mindful of, even if we see these events as low-probability outcomes.

We would 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.

Be mindful of currency exposure

Due to the outperformance of US assets, dollar exposure has increased significantly in many portfolios. The USD proportion in a classic 60:40 portfolio comprised of the MSCI ACWI and the Bloomberg Global Aggregate Bond Index increased from 44% at the start of 2011 to 57% at the end of October 2025, according to data from Bloomberg and MSCI.

From a portfolio management perspective, investors need to pay more attention to currency exposure across asset classes. Despite this year’s depreciation, the US dollar is still fundamentally an expensive currency. Based on our 2026 Long-Term Capital Market Assumptions (LTCMA), we estimate that the US dollar is still 7% above fair value versus EUR, and 8% versus GBP.

In our base case that the US dollar would depreciate in an orderly fashion in the coming years against most of its peer currencies, hedging strategies may look unappealing given relatively high hedging costs (see Exhibit 4). Small and orderly declines in the dollar might not warrant paying for such insurance. However, a disorderly dollar scenarios would make the price of hedging worth paying.

A possible headwind for total equity returns

Since the end of Bretton Woods, a strong US dollar was usually accompanied by the outperformance of US equities relative to the rest of the world (see Exhibit 5). In periods of dollar weakness, the contrary was true. This is intuitive since the attractiveness of equity returns attracts global capital and drives movements in the dollar.

Investors should therefore be mindful of unhedged exposures and how currency moves have the potential to compound any relative underperformance should the US stock market falter. 2025 is a reminder that, in the short term, these swings can be significant. In local currency terms, the S&P 500 was up 18% in the year to the end of November, while for unhedged investors in EUR and GBP the index was up only 5% and 11% respectively.

Our 2026 LTCMAs estimate a fair value for USD to EUR (GBP) of 1.26 (1.48) by 2038. This implies a 0.6% depreciation for the USD per year. Given the expectation of converging short-term yields between currency pairs in the coming years, strategic hedging looks increasingly attractive in a long-term context. In the short term, current hedging cost for EUR investors are a significant handicap to overcome, but adding dollar-hedged equity strategies can provide some protection against policy mistakes and disorderly depreciation.

The safe haven dollar premium may not be what it was

Over the last decade, investors may have been willing to have a larger dollar exposure for the additional protection it afforded them in times of market volatility. Since the height of the global financial crisis, the rolling two-year correlation of the greenback to the performance of the S&P 500 has been almost continuously negative (see Exhibit 6). This meant that US dollar exposure could offset some equity risk. This was particularly evident for crises that occurred outside the US, such as the euro sovereign debt crisis and the outbreak of the Ukraine War.

However, that safe haven status no longer seems as solid. The US dollar’s correlation with the stock market has been growing sharply in 2025. If US policies turn out to be inflationary and destabilising, the dollar is likely to lose its positive diversification effects.

Being mindful of the right balance of currency risk in the portfolio is crucial for future investment success. The addition of currency-hedged strategies and a currency overlay, as well as broad international diversification may mitigate the risks of both more orderly and disorderly dollar declines.