03 October 2025
Structural tailwinds that have supported the US dollar over the past three years appear to be fading: global growth is converging, the US Federal Reserve has started to cut rates, and the European Central Bank is set to hike.
These shifts could signal a tactical window of USD weakness into 2026, especially versus the euro and the yen, though resilient US equity markets remain a key risk to this outlook.
Data as at 25 September 2025. Source: Capital Strategy Research calculations, Bloomberg.
Note: Based on current year and next year consensus GDP forecasts
Until recently, the US economy stood out for its persistent long-term growth, underpinned by robust consumer spending. But data have now slowed across a broad range of indicators, starting with downward revisions to non-farm payrolls in early August. Looking ahead, the combination of ongoing policy uncertainty, tariff pressures, and a cooling labour market is likely to keep the economy on a weaker trajectory, with further slowdown expected as these headwinds continue to build.
In contrast, Europe’s economy is regaining momentum. Services and consumer spending are helping to offset manufacturing headwinds, and labour markets remain robust. In this environment, we expect the euro to appreciate against the dollar as German fiscal stimulus takes effect, while the Japanese yen should benefit as real-rate differentials narrow.
As outlined, a key risk to a more cautious dollar outlook stems from the US equity market. Over the past decade, robust global demand for US equities — especially technology stocks — has been a significant source of dollar strength. Much of this capital has flowed from Japan and Europe, where persistently low interest rates, subdued growth, and investor-deterring policies have redirected investment toward higher-yielding US assets.
Strong returns have also attracted passive investors, including sovereign wealth funds, while limiting capital outflows from the US to emerging markets.
Again, this cycle might be shifting. US equities are trading at exceptionally high valuations, both in absolute terms and compared to global peers, but, equally, if US equities continue to deliver strong results, the dollar may remain resilient despite broader headwinds. More broadly, if the US exceptionalism narrative persists — through equity outperformance or stronger US growth — the US dollar could remain resilient for longer despite the current cyclical headwinds.
Overall, the idea that the US dollar warrants a structural discount — driven by risks to Federal Reserve independence, fiscal vulnerabilities, and growing de-dollarisation narratives — is gaining momentum.
That said, there is no immediate threat to the dollar’s hegemonic status. It continues to serve three foundational roles in the global financial system: as the leading currency for international trade and cross-border capital flows, the dominant component of official reserves, and the private sector’s preferred store of value during periods of economic stress. Moreover, no viable alternative has emerged: the euro lacks a unified safe asset, and the renminbi is constrained by capital controls. Unless other economies develop deeper, more liquid capital markets, the dollar’s hegemonic status is likely to endure — and could even strengthen again under the right conditions.
Thus, while a tactical, possible extended cyclical decline in the dollar is possible, the scale of the US economy and its financial markets should continue to support the currency’s leading position.
Jens Søndergaard is a currency analyst at Capital Group. He has 19 years of investment industry experience and has been with Capital Group for 12 years. Earlier in his career at Capital, he worked as an economist covering the Euro area and the UK. He holds a PhD in economics and a master’s degree in foreign service from Georgetown University. Jens is based in London.
