The dollar is in decline, and investors have to learn to live with it.
The past 12 months were tough for the greenback. The U.S. Dollar Index, which measures the dollar’s value against a basket of developed currencies, slid 8% over the past year—and the list of potential concerns grows longer and longer. They include the breakdown in the U.S.-led multilateral system, growing concern that the dollar will continue to be weaponized through sanctions and seizures, worries about Federal Reserve independence, unease about profligate U.S. government spending, and a long overdue rebalancing as growth and yields abroad become more relatively attractive.
None of that implies the dollar will suddenly fall from grace, abandoned in a wave of panic selling. It isn’t about to lose its reserve status, suddenly replaced by the Chinese yuan or another currency. But the dollar is becoming less popular for savings, for trade, and as the ultimate safe asset. That makes diversification, through international stocks and bonds, especially in emerging markets—and a dollop of gold as a buffer—good options for the years ahead.
If individual investors and large institutions collectively decide to lighten up on their dollars, it will leave a mark. “Some of the U.S. exorbitant privilege will fade,” says Daleep Singh, chief global economist for PGIM’s fixed-income team and former deputy national security adviser in the Biden administration. The cost of losing some of that luster: potentially higher borrowing costs, less capacity to absorb a financial shock, and less ability to create one with sanctions, Singh adds.
The dollar has always been mightier than the size of the U.S. economy suggests it should be. Its share of the global market in currency reserves and international debt issuance is in the range of 60% to 80%, or two to three times the U.S. share of the global economy. For years, critics have argued that the dollar’s place of primacy would erode, to no avail. There was no alternative.
That began to change more than a decade ago as China started to wean itself off the dollar, diversifying reserves into gold while pushing for wider use of its own currency. But the true impetus came with Russia’s invasion of Ukraine, and the sanctions and freezing of assets that followed. The weaponization of the dollar pushed central banks to pare back some of their holdings for gold. President Donald Trump’s push to own Greenland and his constant threats of tariffs rattled European allies and their trust in the U.S., forcing them to consider alternatives as well.
Think of it as quiet quitting rather than a Sell America frenzy. Instead of dumping U.S. Treasuries en masse, many central banks are letting their bondholdings mature and replacing them with gold. Many Treasury investors are cutting U.S. duration risk—moving to shorter-term bonds—says Cameron Brandt, director of research at EPFR.
In the last two months of 2025, net flows into emerging market equity funds totaled $70.8 billion, whereas U.S. equity funds attracted only $43 billion, according to EPFR.
Foreign fund flows have gotten off to a strong start this year as well. While U.S. equity funds saw net outflows of $34 billion in January, international equity funds saw $31 billion of inflows, and emerging market equity funds took in $15 billion, according to Morningstar Direct.
The most notable diversification shift has been among central banks. Gold is expected to account for a quarter of central bank reserves as of the end of 2025, compared with 10% in 2017, with China, Turkey, and Russia seeing the biggest shifts, says Gian Maria Milesi-Ferretti, a senior fellow in the Hutchins Center on Fiscal and Monetary Policy at Brookings.
The U.S. dollar accounts for about 57% of central bank reserves, down from 64% in 2017, as the share of foreign holdings of U.S. Treasuries outstanding by foreign central banks has also declined, notes Milesi-Ferretti. Countries are also using the Chinese yuan in trade financing and foreign direct investment into China. Nonetheless, extensive capital controls in China and the country’s high household savings rate make it hard for the yuan to become a reserve currency contender unless Beijing undertakes extensive structural reforms.
Countries are also introducing measures to further internationalize their own currencies. Europe expanded the use of its global liquidity facilities—like repo lines during periods of market stress—to non-European central banks. India is pushing the use of the rupee in trade settlements and cross-border financing, and 10 European banks have banded together to launch a euro-backed stablecoin later this year.
“It’s more of a quiet diversification away from the dollar,” says Joyce Chang, global head of research at J.P. Morgan. “Dollar diversification and dollar weakness shouldn’t be confused with de-dollarization.”
But even diversification has a way of changing asset behavior. When the dollar reigned supreme, foreign investors could rely on the dollar rising during risk-off periods, partially offsetting losses in U.S. stocks. That has begun to change, forcing foreigners to rethink what makes a good hedge or haven.
“Pension funds around the world constructed portfolios with huge U.S. equity exposure and took the currency risk, based on the old correlations,” says Jens Nordvig, founder of global macro strategy and analytics firm Exante Data. “But that’s now flipping—and that’s a big deal: People will want to hedge the dollar more or want less U.S. equity exposure because it’s expensive to hedge.”
A year ago, Marc Chandler, a veteran currency strategist now at Bannockburn Capital Markets, argued that the dollar wasn’t at risk of being dethroned during an onstage debate at a foreign exchange conference. This year, as he headed back to the conference, he expects a multiyear bear market in the dollar, citing the fracturing of alliances and U.S. concerns about dependence on China for critical supply chains.
The coming Five-Year Plan, China’s blueprint for government priorities, reprioritizes making the yuan a global reserve currency. Beijing has also reportedly told state-owned banks to pivot more away from U.S. Treasuries and toward gold. Regulators are also finding ways to encourage further yuan use in lending and transactions, including by getting more control over the payments architecture to create an alternative to the dollar-dominant Swift system. The share of Chinese goods traded in yuan has more than doubled since 2018 to 28%, and nearly all of China’s trade financing is now done in yuan instead of the dollar.
“That’s not something you see on the Bloomberg screen,” Nordvig says. “And there are all sorts of side effects of that because now new entities have to handle yuan balances in Chinese banks, and that may generate demand for Chinese T-bills or holding gold in China.”
Geopolitics are also helping to improve economic conditions abroad, providing impetus for currencies to strengthen against the dollar. The combination of Russian aggression and uncertain U.S. support has Germany planning to spend one trillion euros ($1.18 trillion) on the military and infrastructure through 2035. Germany’s factory orders in December increased at the biggest pace in two years. That could help revive the German economy—and fuel further gains in industrials, including European defense stocks, which are still cheap compared with U.S. peers.
Japan, too, is at a crossroads. Prime Minister Sanae Takaichi’s plans to revive growth with hefty military spending and a more robust industrial policy caused a sharp selloff in the yen because of fiscal concerns. Japan’s gross debt is already 2.3 times that of its gross domestic product, almost double that of the U.S.
But a landslide victory in snap elections this month gives the Japanese prime minister a powerful mandate for what she describes as a “responsible, proactive fiscal policy” to remake the economy. It’s too early to see if it works, but political stability plus reforms could spark a repatriation of some of the assets that Japanese investors have in the U.S. and push Japanese stocks higher.
A mix of bullish forces are coming together in emerging markets, too. More than a dozen central banks there are poised to cut interest rates—including Brazil—as inflation eases, and business-friendly reforms and a commodities boom spell opportunities for Latin America. Earnings in emerging markets are expected to grow 29% this year, more than double the increase expected in the U.S. The combination of faster growth and declining inflation pressures could force a repricing of emerging market currencies versus the greenback.
The dollar will still see pockets of strength. It recovered a bit in February after Trump nominated former Fed governor Kevin Warsh, viewed as a more traditional pick, as the next Fed chair. The dollar would also get a boost if the U.S. raises interest rates or there’s an easing of geopolitical tensions, like those over Greenland. And despite the talk of dollar weakness, the current decline has only taken it close to the middle of the range it has traded in for the past 30 years, not exactly a sign of the apocalypse.
Even dollar bears aren’t calling for the end of the dollar’s reign as the world’s reserve currency. The dollar is still the most widely used currency—accounting for more than 90% of foreign exchange transactions—and the U.S. is the most liquid and deepest market. There’s no close competitor.
Foreign dependence on the dollar has lessened—but it hasn’t gone away. The extra yield that investors demand to hold long-dated Treasuries is now about 1.25 percentage points, up from zero at the end of 2023. That’s still relatively low historically. And the U.S. hasn’t had to lower the market price to clear the supply of 10-year Treasuries.
Citi strategist Drew Pettit is monitoring gauges like foreign exchange implied volatility to see whether the concerns about a weaker dollar morph into signs that the shift is more than just diversification. So far, implied volatility is currently in the bottom decile of where it has been over the past five years.
American investors in U.S. stocks don’t have much to worry about—the dollar’s direction is one of the smallest factors affecting S&P 500 valuations, Pettit says. Even the benefit of a weaker dollar to U.S. exporters is probably exaggerated, given that global companies are probably making goods abroad and selling them there rather than exporting them.
There are exceptions. Pettit screened for companies with a greater share of foreign sales compared with foreign assets; that highlighted exports in quarterly results; and that disclosed big foreign exchange-related gains in their quarterly reports. Companies meeting those requirements include semiconductor manufacturers Applied Materials, Broadcom, and LAM Research, and healthcare diagnostics companies Agilent Technologies and Bruker.
Dollar weakness has bigger effects abroad. Foreign stocks outperformed U.S. stocks last year, with the MSCI All Country World ex-USA Index up 31% over the past year, more than double the S&P 500’s increase.
The simplest way to take advantage of the trend is to buy a broad exchange fund. Nicholas Colas, co-founder of DataTrek Research, has been telling clients to get allocations back in line with the MSCI All Country World Index, which has 65% of assets in the U.S. and 35% elsewhere. Funds like the iShares MSCI ACWI exchange-traded fund or the Vanguard Total World ETF offer a quick way to do that on the cheap.
Neither holds large stakes in emerging markets. Two cheap ways to tap those markets: the Vanguard FTSE Emerging Markets ETF, which excludes South Korea and has about half of its allocation in China and Taiwan, and 20% in India, but with limited exposure to Latin America, and the iShares MSCI Emerging Markets ex-China ETF, which steers clear of China and has about 10% in Latin America. For someone looking to allocate more to the continent, a regionally focused fund like the iShares Latin America 40 ETF is a better option.
The biggest beneficiaries of a weak dollar could be overseas bond markets. Vishal Khanduja, a manager of the Eaton Vance Total Return Bond fund, says its allocation to foreign assets was at 6% by year end, the highest level in five years. The draw: Real yields are improving elsewhere around the world as central banks begin to diversify, and there’s a shift in how investors are hedging.
Instead of investment-grade bonds of U.S. financial companies, Khanduja is opting for the bonds of European financial companies, as the economic backdrop is benign and credit conditions are holding up. Plus, the interest-rate differential works in the favor of U.S. investors after they convert the currency back. He is also finding opportunities for high yields in Mexico and Brazil, where he thinks investors are well compensated for potential political risks around trade and Brazil’s presidential election later this year.
Tina Vandersteel, who runs GMO’s emerging country debt team, sees a once-in-a-generation opportunity in local-denominated debt in emerging markets with the asset class extremely cheap, currencies poised to strengthen, and a generous carry, or interest-rate pickup versus U.S. bonds. A cheap way to get access: the iShares J.P. Morgan EM Local Currency Bond ETF for those willing to take on a bit of extra risk, and the Vanguard Total International Bond EFT for investment-grade bonds abroad.
As the dollar weakens, U.S. Treasuries are also likely to lose their haven status—the ability to gain value when other assets fall—which means looking elsewhere for safety. Gold has become the consensus choice, even as volatility has increased with its price. Bridgewater Associates founder Ray Dalio suggests that investors target a 5% to 15% stake of their portfolio in the precious metal.
Continued reallocation could provide a tailwind for gold. If investors nudged their allocations to just 3.5% from 3%, J.P. Morgan’s Chang says that could translate to $6,000 gold, while a move to 4.6% in coming years could push the price as high as $8,500. Ed Yardeni, of Yardeni Research, told clients in a recent note that $10,000 gold by the end of 2029 is plausible.
Gold’s rise is the clearest sign that investors are rethinking assumptions about the dollar. It might not be Sell America, but after decades of U.S. dollar dominance, it’s time to do more buying elsewhere.
Write to Reshma Kapadia at reshma.kapadia@barrons.com