The US dollar has always held a central place in the global financial system. In 2025, dramatic shifts in its value shook markets and investor confidence worldwide. Understanding these movements is no longer optional for portfolio managers and individual investors alike.
In this in-depth analysis, we explore the drivers behind recent currency swings, quantify their impact on various asset classes, and offer practical strategies for resilient portfolios in an era of heightened volatility.
Drivers of Recent Dollar Movements
The first half of 2025 saw the dollar decline by 10% against major currencies, marking its worst start in 50 years. This move stemmed from a convergence of economic headwinds and evolving investor behavior.
Key forces shaping the dollar’s path include:
- Monetary and fiscal policy uncertainty: Anticipated Fed rate cuts amid slowing growth have undermined dollar strength.
- foreign investors increasing currency hedges: Rising hedging activity on U.S. assets has amplified downward pressure.
- Concerns over U.S. deficit and trade policy volatility added to market unease.
Current State and Performance
After its precipitous drop through mid-2025, the dollar stabilized but remained under pressure. Consensus GDP growth forecasts for 2025 fell from 2.3% to 1.4%, reducing the case for higher rates and fueling further depreciation expectations.
Meanwhile, foreign holders now own 27% ($7.6 trillion) of marketable U.S. Treasury debt and 20% ($18 trillion) of total U.S. assets. As these investors reappraised currency risk, unhedged positions on U.S. equities shrank, halving net ETF inflows from $10.2 billion to $5.7 billion per month.
Impacts Across Asset Classes
A weaker dollar delivered a powerful tailwind to non-U.S. markets. The MSCI EAFE index gained 22% YTD, nearly half attributable to currency moves, while the Morningstar Korea Index soared 75% in dollar terms.
By contrast, U.S. multinational exporters enjoyed stronger foreign earnings, but import costs began to rise, creating potential inflation pressures at home.
Investor Positioning and Strategies
Amid these shifts, investors can adopt multiple approaches to navigate currency risks and opportunities. No single strategy fits all, but a thoughtful blend of diversification, hedging, and selective exposure can enhance outcomes.
- strategic global diversification and hedging: Balance unhedged positions during downtrends with tactical hedges against sharp reversals.
- Target high-growth U.S. sectors (e.g., AI) for yield amid currency headwinds.
- Allocate to EM local-currency debt and non-U.S. equities when dollar momentum fades.
Historical Context and Long-Term Trends
Currency cycles are persistent but not permanent cycles. Major episodes of dollar weakness—such as post-Plaza Accord in 1985 or early 2000s—preceded sustained international outperformance, only to reverse in the 2013–2022 bull market.
Similarly, policy shocks like trade wars or fiscal crises can trigger abrupt currency moves, underscoring the need for a steady, diversified approach rather than market timing.
Practical Considerations and Risks
Investors must grapple with the complexities of currency translation, basis risk in hedged products, and the temptation to overconcentrate in high-momentum regions.
- Understand how exchange rate shifts affect corporate earnings and bond yields.
- Beware of hedging costs that may erode benefits in prolonged downtrends.
- Monitor central bank statements and fiscal developments as early warning signals.
Looking Ahead: Scenarios and Expert Views
Projections for the next 18 months vary. Morgan Stanley sees another largest annual drop this century possible by end-2026, citing labor market softening and policy unpredictability. J.P. Morgan agrees on growth pressures but highlights potential stabilizing factors if deficits moderate.
Key scenarios include a modest dollar rebound if U.S. growth outperforms peers, or continued weakness as global diversification accelerates. For nimble investors, contrarian opportunities may emerge when oversold conditions reverse.
Ultimately, currency movements will remain a critical determinant of cross-border investment success. By combining sound macro analysis with disciplined portfolio construction, investors can harness dollar-driven capital flow shifts to their advantage.
