From our trading perspective, the US dollar may still be in an overvalued range, and its fundamental support is gradually weakening. Among the 33 currencies covered by our valuation model, only nine have a higher valuation level than the US dollar. As the advantages of the 'American exceptionalism' gradually fade, the 'dividend window' for the US dollar may be nearing its end, and it is likely to enter a depreciation cycle in the coming years.
The contraction in foreign capital inflows, capital outflows driven by hedging needs, persistent debt pressures, and concerns over the Federal Reserve's policy independence all point to a more challenging operating environment for the US dollar.
However, it should be clarified that the US dollar's position as the world's core reserve currency remains deeply entrenched. Short-term challenges to its dominance may weaken its safe-haven status, but compared to the deep structural changes required for the global economy to shift to another core reserve asset, the actual impact of such risks remains relatively limited.
High debt levels and chronic current account deficits have led to a sharp increase in reliance on external financing.
From a fiscal perspective, there is currently no viable budget-balancing plan for the United States, and the government debt-to-GDP ratio is likely to continue rising. The only mitigating factor is that the debt service ratios of American households and businesses remain below their long-term averages (representing the proportion of income used to cover principal and interest payments; the lower the ratio, the stronger the debt servicing capacity), providing some short-term relief for financial system pressures. However, fiscal vulnerabilities are steadily accumulating.
In terms of external balance, the widening share of the US current account deficit relative to GDP underscores the increasing dependence of the US economy on external capital. This contrasts sharply with economies like Germany and Japan, which maintain persistent current account surpluses. Additionally, the US holds a substantial negative net international investment position, further confirming its heavy reliance on overseas financing.
(Trend chart of US government debt as a percentage of GDP)
Changes in the attractiveness of US assets bring risks of capital flow volatility.
From the perspective of foreign holdings, foreign investors currently hold approximately US$18 trillion in U.S. equities (about 20% of the total market size) and US$7 trillion in U.S. Treasuries (approximately 25% of the total market size).
A slowdown in U.S. economic growth, diminishing relative advantages of the stock market, and rising fiscal concerns could all reduce the attractiveness of U.S. assets, leading to a decline in portfolio investment inflows or even triggering capital outflows. Recent fluctuations in the foreign exchange market have clearly demonstrated that the reallocation of foreign investors' equity holdings is directly impacting exchange rate movements, while a significant portion of holdings in U.S. assets remains exposed to rebalancing risks.
(The global trend of reducing U.S. Treasury holdings persists, but U.S. equity assets remain highly sought after.)
Erosion of Dollar Hegemony and the Trend Toward Currency Diversification
In terms of international status, although the U.S. dollar continues to dominate the global financial system, the stability of its hegemonic position has significantly declined compared to the past. While there is no immediate threat to its status as a reserve currency, the trend toward currency diversification has substantively begun. Central banks around the world are steadily increasing their gold reserves (according to the IMF's 2025 mid-year report, emerging market central banks increased their gold reserves by 23% year-on-year in the first half of 2025, with India and Brazil’s central banks being among the largest purchasers), a move that essentially reflects market pricing of concerns over U.S. fiscal sustainability and potential dollar depreciation risks.
However, it should be noted that gold cannot fully replace the functions of the U.S. dollar—it does not generate income and lacks sufficient practicality in global trade settlement and financial transactions. Meanwhile, there is currently no competitive alternative reserve currency globally. The transition to a multi-currency reserve system, while feasible, will be extremely slow.
Currently, nine out of every ten foreign exchange transactions involve the U.S. dollar, accounting for about 50% of global trade settlements, nearly 60% of official foreign exchange reserves, and possessing unparalleled market depth and liquidity advantages.
(The proportion of gold in countries' reserve assets continues to rise.)
The credibility of the central bank undermines the safe-haven attribute of the US dollar.
From a historical perspective, the US dollar typically plays the role of a core safe-haven tool during stock market corrections. However, in April this year, the rare scenario of the US dollar and stock markets plunging simultaneously occurred, driven by multiple factors including escalating tariff risks, declining confidence in US institutional credibility, and margin calls driven by liquidity constraints. Despite this, rising deficit levels, increasing political polarization, and a highly leveraged financial system may still erode the reliability of the US dollar as a safe haven in future crises.
In terms of central bank credibility, amid surging inflation following the pandemic, the Federal Reserve demonstrated a clear commitment to combating inflation—aggressively raising interest rates and reducing its balance sheet by nearly $2 trillion without causing substantial harm to the labor market. Current inflation expectations remain anchored, further solidifying the Fed's policy credibility. However, on July 16 this year, news about the potential removal of Powell triggered significant market volatility: the US Dollar Index fell by approximately 1.2% during the noon session that day, abruptly ending a nine-day winning streak.
Political interference has become a new risk factor for the US dollar. The Trump administration pressured the Federal Reserve to cut interest rates more aggressively and even attempted to remove Fed Governor Lisa Cook—an unprecedented move that highlighted the risk of compromised independence in the Fed’s policymaking. Although existing institutional safeguards continue to protect the Fed's decision-making autonomy, growing concerns over 'fiscal dominance'—where monetary policy succumbs to government financing needs—may gradually weaken investor confidence in US dollar assets.
Geopolitical crises involving tariffs provide more scenarios where the US dollar could face shocks.
On the geopolitical risk front, geopolitics has become one of the core drivers influencing fluctuations in the US dollar exchange rate. Tariff policy announcements have directly reshaped market expectations for economic growth and inflation, with the US being more vulnerable to such policy shocks compared to other economies.
The US trade war remains a major focus globally. Persistent pressure from the US President, coupled with the lack of enforcement, has even led to the emergence of the TACO trading strategy (Trump Always Chickens Out). Meanwhile, the ongoing conflict between Russia and Ukraine continues to generate uncertainties, all of which could undermine the credibility of the US dollar. Last Friday, the US became embroiled in another tariff crisis; concerns over US tariffs caused both the US Dollar Index and US stock markets to decline simultaneously.
At the same time, the much-anticipated meeting between Trump and Putin drew widespread market attention. Although the dialogue prospects might help ease localized tensions, any scenario leading to greater direct US involvement in conflicts will pose significant downside risks to the US dollar—especially against the backdrop of already weakened investor confidence in US institutions.
Summary:
Thu Lan Nguyen of Commerzbank noted in a research report that the decline in the US dollar has been limited so far because most people seem to expect both sides of the tariff dispute to reach another agreement. However, the risk of escalating tensions appears higher. If countries decide to distance themselves from the US and strengthen ties with other trading partners, the US could become increasingly isolated.
However, the US dollar remains the cornerstone of the global financial system, underpinned by unparalleled liquidity, deep capital markets, and extensive market trust. Yet, traders must recognize that this resilience does not equate to being "invincible." The current valuation of the dollar remains elevated, while the structural factors that have long supported the U.S. economy and its financial dominance are steadily weakening.
(The U.S. Dollar Index remains strong on the daily chart, staying above the 5-day moving average, Source: Yihui Express)
Looking ahead to the coming years, with increasing fiscal pressures, slowing economic growth momentum, and accelerating currency diversification, the U.S. dollar is likely to gradually enter a depreciation phase. However, it is important to note that this does not imply the dollar will soon lose its status as a reserve currency; currently, the U.S. Dollar Index is still rebounding and appears poised for further gains.
Nevertheless, it does signal to investors the need to prepare for a market environment where the 'U.S. dollar exceptionality' is diminishing.
At 20:13 Beijing Time, the U.S. Dollar Index is currently quoted at 99.20.