For now for this discussion, I will use the DXY Index since it’s the most commonly used in the markets
It is a weighted geometric mean of the dollar’s value relative to the following select currencies:
I already did a small post here, outlining that the dollar had a very significant 7% rally since July, and that due to the importance of the dollar around the world for all type of transactions, this is probably going to put additional constraints on global liquidity.
Since then, the DXY is having a bit of a decline, but the point is still valid, especially if in the near term the dollar continues on a path higher. The best scenario could be to see it at least stabilize.
IMO the current rise in treasury yields we are experiencing, along with a better economic outlook for the US than for other developed economies (especially with the data released during Q3) could be among the reasons.
I recently saw this photo, which shows the dominance of the dollar in payments, and the increase it has recently
And this chart from JPM, shows while the dollar has a lost share in global exports, is still extremely dominant in FX volume.
Looking at FX volumes, the dollar’s share stands at 88%, near record highs, while its share of trade invoicing, cross-border liabilities and foreign currency debt issuance has held steady over the last two decades. “The dollar’s transactional dominance remains top-of-class despite secular declines in U.S. trade shares. On the other hand, de-dollarization is evident in FX reserves, where the dollar’s share has declined to a record low of 58%,” Chandan noted.
Good analysis. I agree with higher yields and relatively strong U.S economic developments as major reasons for the recent dollar strength.
When it comes to transaction volume through Swift I think the decline in international Euro transactions could be caused by the fact that Europeans are increasingly using another network (SEPA) which is supporting real-time transactions esp. since 1-2 years but we could look into that transaction topic separately at one point to understand international money flows better.
Foreign Currency Reserves, is another data point where the dollar is clearly still very dominant. Even if its share has been declining, 12 percentage points—from 71 to 59 percent—since the euro was launched in 1999
This is a very unusual movement, as these markets tend to move in the same direction usually (lower yields-> weaker dollar), and it could signal several things:
IMO is probably a combination of several of these things (we will only have clarity until we get updates on treasuries holdings and US reserves). I am currently starting to be confident that Trump trade wars if sustained will only undermine the US dollar reserve currency status ultimately in the long term, because the US is very vulnerable actually due to its huge debt burden and the importance foreign holdings of US debt have.
And I think these unusual movements in markets: yields rising despite recession fears, and the dollar falling despite yields rising could be starting to be signs of what this could be like it if this indeed is the case.
What is your recommendation here?
I don’t have deep insights into this topic but I think understanding Trumps plan to weaken the dollar and other countries like China selling treasuries and then dollar could both be key points here.
If other countries see U.S debt as less trustworthy and push to settle trade in other currencies (I am not sure how much China settles in yuan) that could be huge for the value of the dollar.
Ideally I would like strong arguments for both sides (dollar strength & weakness), an indication how those arguments should be weighted in importance and ultimately a recommendation what to do with dollar holdings.
Do you have a take by how the dollar exchange ratios are driven by speculation and investments vs. business activity or other things?
Which factors would we need to focus on to get a take about its short or medium term direction?
Edit: Following your post here we now have an overview of volumes by different counterparties.
I wonder if it is possible to determine which kind of transactions are driving exchange ratios the most.
I think it could be a smaller subset of volumes as
On the other side forward fx contracts with one leg should certainly have an impact via arbitrage. (GPT)
I think business activity might not show up in BiS numbers as businesses use banks or specialized financial intermediaries for their fx hedges instead of having other businesses as counterparty (see gpt prompts from above) but might be important for exchange rates nevertheless.
Other factors are obvs. positioning of investors, states, carry trades etc. etc.
Overall I would like to try not to join this research too much because I am busy with other topics but I just wanted to share those thoughts. I would be looking for more finalized conclusions and insights what is driving exchange rates and consequently analysis of those factors established as most important in the current situation and an assessment how EUR.USD will likely develop in the future. I am aware that producing this could take a bit of time so having first indications would be great before potentially going more in depth.
@Magaly
Currently, I think the short and medium term is probably most likely about capital flows, asset allocations, and risk perceptions of each economy.
Trade and business activity movements are probably smoother and with a longer-term impact, unless we are already in a full-blown recession or crisis, which is currently not the case.
I explores this with GPT, this was also his summary:
On top of this, dollar exchange rates are influenced not only by these cyclical and market-specific factors, but also by the U.S. dollar’s role as a global reserve currency and its significant share in most world transactions. This structural demand has kept the dollar [overvalued for extended periods (GPT).
So even if there are shifts in risk perceptions for the US, if there is ever a global USD liquidity shortage or USD needs increase, the dollar will still get strong in these events.
I agree that FX swaps are mostly neutral, unless there is a USD global liquidity crisis (GPT), which doesn’t seem to be the case currently. So, most of the movements are probably spot and forward contracts currently.
From my research, I found is true that the current foreign US exposure is very large ($62 trillion assets), and it has grown significantly in the past 5 years. Everyone was indeed betting on “US exceptionalism”.
I also found they also have been seeling in 2025, the most in years, which for me it makes sense, if you have significant exposure to US assets, and you have had significant gains in the past few years, is natural for me that investors take profits and diversify away a bit from the US when significant headwinds start to appear.
So for me, we need to focus on the short and medium term on:
(btw I am just responding you question here, but I will create a more detailed assessment of what I think could be happening. As you said, this is a very complex market, and will take me time to really get a good understanding of it)
EUR/USD: Recent Movements and Drivers
Bullish EUR/USD (Bearish USD) Case
Bearish EUR/USD (Bullish USD) Case
Final Assessment:
My probabilities here are still with very low confidence
“Real money flows have been the big driver of the EUR/USD rally as investors either raise dollar hedge ratios or repatriate US assets completely. We are not major subscribers to the dollar having permanently lost its safe haven status, but acknowledge that lower US growth rates are coming and that Federal Reserve easing in the second half will hit the dollar broadly.”
“We’re thinking EUR/USD could trade in a volatile 1.12-1.16 range this quarter, where renewed bouts of US equity selling can see new EUR/USD highs hit. Expect volatility to remain high. However, the euro is now getting very strong for the European Central Bank, and the deposit rate being cut to 1.75% should restrain EUR/USD a little”.
“In our analysis of long-term trends in exchange rate markets, we look at especially three parameters: 1) the real rate parity, 2) the relative attractiveness of the asset market and 3) the outlook for global monetary conditions. In short, the outlook for building block 1 and 2 but potentially also 3) have turned. While a US recession in 2025 is not yet our base case, the probability has risen meaningfully — now priced at around 60% in prediction markets. This rising risk, alongside Trump’s policy stance, poses a growing drag on the structural growth outlook for the US.”
“Policies aimed at reducing immigration, cutting federal employment (e.g. DOGE), and weakening productivity dynamics are all negative for long-term US potential growth. This points to narrower real rate differentials ahead — a fundamental shift that reduces USD support. Simultaneously, there are early but clear signs of capital rotation out of US assets. If this shift proves structural — particularly a rotation away from the US tech sector — it would mark a break from the dominant investment narrative of the past decade, with USD-negative implications.”
“On the EUR side, Europe’s fiscal reform push is beginning to support sentiment. But the more important driver of our revised view is the growing unpredictability of US politics. With the US increasingly at odds with its allies and global institutions, we believe the relative risk premium on US assets is rising — and over time, that will weigh on the USD. In sum, we revise our EUR/USD forecast profile to 1.11 in 1M (from 1.09), 1.12 in 3M (1.08), 1.14 in 6M (1.07) and 1.14 in 12M (1.06).”
Conclusion:
Goldman Sachs is now firmly in the Dollar bearish camp, betting that weakening US fundamentals and fading exceptionalism will continue to drive structural dollar depreciation. The EUR stands out as a key beneficiary, with EUR/USD now expected to rally towards 1.20 by year-end.
According to Deutsche, fair value for EUR/USD is in the 1.25-1.30 range which will act as an anchor for the pair amid geo-political uncertainty.
It also sees the risk of sustained global diversification away from the US dollar amid political uncertainty, trade concerns and weaker growth.
Deutsche Bank considers the potential risk of substantial capital flows out of US markets.
The bank notes foreigners own $7 trillion of American fixed income and $18 trillion of American equities. For example, European portfolio holdings of US equities have risen from 5% to 20% since 2010 and that unhedged FX exposure to US assets is very high.
A substantial reallocation of assets would involve heavy dollar selling.
The bank did note that a dovish ECB policy would curb Euro gains.
Citi: Citi forecasts the euro hitting highs around $1.20 in the next six to 12 months, before the dollar could start to make a comeback.
MUFG: Euro to Dollar Forecasts HIKED to 1.20 at MUFG Over Twelve Month Timeline
MUFG considers that bond-market vulnerability is another key element.
The 10-year yield spiked to highs around 4.58% before correcting slightly.
According to the bank; “We believe it’s no coincidence that the turmoil has unfolded in the same week that we have had developments in regard to Trump’s proposed tax cut plans.
The House has agreed a budget that extends the 2027 tax cuts. According to the Congressional Budget Office, fiscal measures overall would increase the US debt by at least $5trn over 10 years.
According to MUFG; “The US fiscal deficit is simply out of control and there appears little appetite in Congress amongst Republicans to tackle the issue.”
It added; “The US dollar has also completely detached from rate spreads underlining the crisis of confidence feel to US dollar moves. There are numerous factors that have created these financial market conditions and until some of these are addressed it is difficult to see a turnaround in current market direction.”
I will continue adding as I encounter more
We believe the re-think of the risk and reward of Dollar assets has room to run and expect the USD to extend its declines over time… USD weakness has detached from interest rate differentials and the 10-year forward EUR/$ rate has appreciated alongside the spot rate, hinting at a deeper structural change.
The unusual ‘EM-style correlations’ (USD down/equities down/yields higher) that we have seen recently may share features with the unwind of an ‘EM-style carry trade’—where leveraged investors who are long US assets, FX-unhedged, are forced by political events to rapidly re-assess those return and quality prospects, and shift to more diversified portfolios. Even if foreign investors do not sell their US assets, there is plenty of room for hedge ratios to rise.
