Where now for the dollar?

After a decade of strength, the US dollar, as measured by the Dollar Index (DXY), is down 7.1% year-to-date. The question for many investors is this: Will the dollar decline, stabilize or strengthen from here?

For now, it seems that—whether as a vehicle used to facilitate trade, as a reserve for a country’s trade surplus or as a harbor of safety—asset managers, companies and central banks are looking for alternatives.

Here, the story of gold over the past three years is illustrative. China has diverted part of its trade surplus that might have gone into US Treasurys and bought physical gold. Meanwhile, gold has soared to multi-year highs, moving from about $1,500 in early 2020 to over $3,200 today.

We’ve also seen the prospect of weaker US growth at least in the short term. Could this force the Federal Reserve to cut interest rates, shrinking the dollar’s yield advantage and sending investors into other assets? That yield advantage over the last 10 years has been one of the main drivers of dollar strength. Our view is that easier fiscal policies in Germany and China could help to bolster their economies, reducing excess savings flows into US assets.

Geopolitics is also a factor. Since 2022 and the confiscation of Russia’s foreign currency reserves, foreign investors have reduced their investments in US Treasurys and allocated capital surpluses into US equities, particularly the Magnificent Seven. With the Magnificent Seven down so far this year and the introduction of DeepSeek, this trade doesn’t look quite as attractive.

Given this backdrop, our view is that the decade-long period of dollar strength may now be coming to an end. If so, investors may look to other countries and other markets to invest their surpluses.

But where might these surpluses go? There are alternatives but not all of them are straightforward.

Gold is one option. We’ve seen this in recent years with China becoming a major buyer of physical gold. However, with its very finite supply, gold is not a sustainable alternative.

How about other commodities? As the US has become more isolationist, it may be prudent for countries to start building inventories of necessary commodities. Or perhaps foreign assets? We see sovereign wealth funds and international investors beginning to move away from the US to Europe, East Asia and India—and this could be set to continue.

None of this is to suggest that the dollar will lose its reserve status any time soon. We don’t believe that’s in the cards, for several reasons:

• No true alternative. No other currency has enough liquidity to meet global demand. The dollar continues to be the dominant foreign exchange reserve with over $12.36 trillion held by central banks.
• Free floating. The dollar is a free-floating currency, meaning that the free market sets its value every day. It is not “pegged” to something else or controlled by a government.
• Rule of law. The stability of the US justice system and its contract laws and private property rights provide global investors with a sense of confidence. This feature, however, is being questioned more and more since the US and other Western governments seized Russia’s foreign currency reserves after Russia invaded Ukraine.

US Treasurys were once the sole instrument for investment during times of economic and geopolitical turmoil, but this may be changing. As demand for the dollar falls, and more attractive investment opportunities outside the US present themselves, we can expect to see a modulation of the decades-long status quo where the dollar alone was ascendent.

We believe that navigating these rough waters will take an experienced, steady hand. Active management and an eye to international diversification could be the name of the game from here.