Is the Dollar Entering a Period of Long-Term Structural Weakness?

Sustained decline seems likely because the current sell-off isn’t following expected price action dynamics

• The U.S. dollar is dropping at a blistering speed against its major currency peers.
• Familiar support from rising interest rates and risk aversion has failed to appear.
• Enduring regime change to a weaker dollar means rebounds are likely to be sold.

The U.S. dollar has suffered steep losses since the beginning of the year. The currency is down nearly 10% against an average of its major counterparts—the euro, British pound, Japanese yen and Australian dollars.

This puts 2025 on pace to be the worst year for the greenback since 2017, and the second quarter has only just begun. Moreover, the sell-off has bucked familiar trading patterns, marking a worrying break from price action dynamics that have persisted since the currency’s tether to gold was broken in 1973.

U.S. dollar: thriving on extremes

The dollar occupies a special place in the global financial system. Data from the Bank of International Settlements (BIS)—the so-called “central bank for central banks”—reveals in its triannual survey of foreign exchange markets that as of 2022, the currency accounted for 88% of the total average daily turnover of $7.5 trillion.

That makes the greenback uniquely liquid, even when compared to broadly traded counterparts like the euro or the yen. For traders, this makes for price action dynamics unlike most other currencies. They have been famously illustrated by the Dollar Smile model, developed by economists Stephen Jen and Fatih Yilmaz.

This framework ties the dollar’s performance to the relative strength of the U.S. economy against that of its major peers. It reveals the currency tends to rise when U.S. growth either significantly leads or lags compared with average growth in the G7 economies (excluding the U.S. itself).

The right side of the chart tells a familiar story. When the U.S. economy is outperforming, brisk growth is bidding up inflation and pushing the Federal Reserve to raise interest rates. That expands the dollar’s yield advantage against its lagging counterparts and pushes it upward. This is the way most currencies tend to work.

The left side is where the dollar’s unique properties shine. The U.S. is the world’s largest economy. If growth there is lagging in a meaningful way, the knock-on effect on overall global growth is understandably damaging. It isn’t difficult to imagine that markets might turn defensive in such a scenario, with money flowing away from risky assets and toward safety.

It likewise follows that much of this “cashing out” has tended to pour into the greenback. Its unrivaled liquidity means that it can absorb large-scale capital inflows with less volatility than the alternatives, which is a clear advantage when investors are in flight mode. Its ubiquity also means redeploying capital is easier after whatever scare subsides.

Currency markets in 2025: uncharted territory?

Look now at crumbling stock markets and surging Treasury bond yields, and you might expect the dollar to be thriving. Rates have stormed higher from early April lows, delivering the biggest weekly gains in seven months at the front end. The long end saw its best week since March 2022. The bellwether S&P 500 index is flirting with 15-month lows.

That neither yield appeal nor haven demand are able to underpin the beleaguered U.S. currency implies that its fundamental foundations have been challenged—and perhaps even wounded—in a critical way. Breaking down the constituent parts of U.S. Treasury bond yields reveals the nature of the threat.

The cost of compensation for duration risk embedded in the benchmark 10-year note, the so-called “term premium,” has jumped to the highest share of the interest rate since May 2021. That speaks to increasingly acute concern about the U.S. fiscal trajectory after the rocky rollout of a new tariff regime by the Trump administration.

Parallel declines in U.S. stocks, bonds and the currency point to an exodus from dollar-denominated assets. This shift seems likely to endure beyond the near- to medium-term impact of repricing for a vastly different approach to economic policymaking from Washington, DC.

That is because the undoing of global trade links will almost certainly reduce cross-border commerce and leave foreigners holding fewer dollars. Growing trade incentivized them to recycle this capital back into U.S. markets to sustain the dollar’s purchasing power, underpinning demand for imports. On current trends, these inflows may become a trickle.

Federal Reserve interest rate cuts to combat cyclical weakness are expected to follow from the breakdown of U.S.-led economic norms may hurt the dollar further. Still, markets don’t tend to move in straight lines. This means that any sizable near-term pullback in top dollar alternatives like the euro and the yen are probably buying opportunities.

Ilya Spivak, tastylive head of global macro, has 15 years of experience in trading strategy, and he specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak

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