Early 2025: A shift in dollar dynamics?
In early 2025, the dollar began to exhibit uncharacteristic weakness—even during episodes of global risk aversion. This marked a departure from its traditional safe-haven behavior. The initial impetus for this weakness stemmed from improving investment prospects outside the US. The emergence of competitive Chinese AI models, reshaping perceptions of future tech sector leadership, coupled with European fiscal stimulus, particularly in Germany, challenged the “TINA” (“There Is No Alternative”) narrative that had previously favored US assets. This shift is reflected in increased fund flows into European assets, resulting in appreciation of the euro against the dollar, reversing the depreciation observed in 2024.
In April, dollar weakness was driven less by the newly announced tariffs as part of the US Administration’s stated goal of reducing the trade deficit, and more by concerns over the perceived uncertainty around the broader tariff strategy.1 The broad and uncertain nature of the reciprocal tariffs unsettled markets and weakened investor confidence in the US as a stable anchor. Additionally, new domestic policies and speculation around a so-called “Mar-a-Lago Accord”—a hypothetical strategy loosely inspired by the 1985 Plaza Accord—may have contributed to recent downward pressure on the US dollar. The idea centers on deliberately weakening the dollar to enhance US export competitiveness. Current US fiscal policy implies sustained large deficits well into the future. As a result, continued recycling of global current account surpluses into US assets—flows that typically support the dollar rather than weaken it—is likely to remain necessary to help contain the cost of financing those deficits.
More recently, dollar softness has shifted from being a broad macro story to a more targeted one—centered on currencies from countries with large positive Net International Investment Positions (NIIPs), such as the Taiwanese dollar and Singapore dollar. These currencies have been historically undervalued due to years of capital recycling: surplus economies have exported goods to the US, earned dollars, and reinvested those dollars into US financial assets. This flow has supported the dollar and suppressed appreciation in their own currencies. Now, that dynamic is beginning to shift. US trade negotiations may be encouraging surplus countries to allow their currencies to appreciate, enhancing US export competitiveness.
Moody’s downgrade of US sovereign debt—from Aaa to Aa1 on May 16, 2025—has renewed focus on the country’s fiscal sustainability. While the decision was largely anticipated, it highlights growing concern over the persistence of substantial budget deficits, even amid solid economic growth and a strong labor market. This backdrop may also be contributing to a more cautious outlook on the US dollar.
This dollar weakness is atypical and contrasts with the 2018–2019 trade war, when the dollar strengthened. During that period, safe-haven flows, strong US growth, Fed tightening, and emerging market stress all supported the dollar.
Catalysts for a sustained downtrend: Regional diversification and rising hedge ratios
Despite the early 2025 weakness, the dollar still appears overvalued based on multiple valuation frameworks. These include purchasing power parity (PPP) adjusted for productivity—favored by our Fixed Income team—and the Goldman Sachs Dynamic Equilibrium Exchange Rate (DEER) model, which incorporates long-term fundamentals such as productivity and terms of trade. However, valuation alone rarely triggers currency moves. A sustained downtrend typically requires a macro catalyst—such as a policy pivot, recession, geopolitical shock or reallocation of assets.
Several structural factors could contribute to a gradual rebalancing in global asset allocations. These include persistent concerns over US institutional credibility, elevated concentration in US equity markets, and improving investment opportunities abroad. Together, these dynamics may encourage greater regional diversification—in line with the Embracing a Broader Equity Landscape theme.
