The greenback has had a rough ride in 2025, down roughly 9% so far this year.
Yet this weakness has not played out evenly across global currencies. The Swiss franc, the euro and the Norwegian and Swedish krona have rallied strongly, while others, such as the Japanese yen and Canadian dollar, have been broadly flat.
This uneven performance reflects diverging inflation trends, growth dynamics and central bank policies shaping the global currency landscape.
On paper, the dollar still appears expensive when adjusted for inflation (its real effective exchange rate) and compared with a broad basket of trading partners, though currencies can remain mispriced for long periods. The yen, for instance, has looked undervalued for years without a sustained recovery.
Ultimately, investors do not buy currencies simply because they are cheap – they respond to relative interest rates, growth prospects and perceptions of safety.
Seasonal tailwinds and risk events
Seasonal trends typically support the dollar through October and November, before giving way to weakness in December as risk assets, particularly equities, enjoy their traditional ‘Santa rally’.
Lately, the dollar has become more sensitive to short-term risk sentiment, showing a strong negative correlation with global macro risk that hints its haven status may be returning. However, if the next wave of market anxiety comes from the US – such as the government shutdown or renewed banking stress – the dollar’s safe-haven appeal during these turbulent months could come into question.
Meanwhile, trade flows continue to dominate currency behaviours with energy exporters like Norway and, to a lesser extent, Canada enjoying trade surpluses supporting their currencies, while the US still runs a deficit.
Yet since the 2024 election, even a narrowing US deficit has failed to lift the dollar. This may suggest the greenback has fallen out of favour, or that the US economy is evolving in ways traditional models no longer capture, as AI-driven investment reshapes productivity and capital flows.
A major draw for investors remains real yields – interest rates adjusted for inflation – which, even after declining this year, are still high in the US compared with most major economies. Only Australia and Norway offer meaningfully higher returns.
Markets currently expect the Federal Reserve to cut rates by around 1.25 percentage points over the next year, but if inflation stabilises and the Fed ends up cutting less than expected, real yields could rise again, providing support for the dollar.
Higher yields also make it more expensive to hedge against low-yield currencies, like the Japanese yen and Canadian dollar, which can, in turn, reduce selling pressure on the greenback.
QT nearing the finish line
Fed Chair Jerome Powell has hinted that the central bank may soon end ‘quantitative tightening’ (QT), the process of shrinking its balance sheet. The Fed’s assets have already fallen from a US$9 trillion peak to about US$6.5 trillion. Ending QT is generally viewed as negative for the dollar since it increases liquidity in the financial system.
However, if this steadies the US Treasury market, eases bank-funding strains, and lowers mortgage rates, it could support US growth – and that can attract flows back into the dollar.
US growth remains resilient, with Q2 GDP expanding by 3.8% and Q3 tracking similarly, yet markets still expect rate cuts. That is because much of today’s growth is driven by investment, which boosts productivity and asset markets more than employment.
Meanwhile, the Fed’s preferred inflation gauge (core PCE) remains near 3%, leaving policymakers torn between cutting too soon and risking higher inflation or holding steady and causing damage to the job market.
Looking to 2026, the US is set to outgrow Europe and Japan, with only Australia close behind – supportive for capital inflows and the currency.
The fiscal wild card
Perhaps the biggest long-term concern for the dollar remains America’s fiscal position.
The US is projected to run a deficit of about 6.5% of GDP in 2026 – larger than this year’s shortfall – requiring roughly US$2 trillion in annual borrowing.
Such persistent spending can push long-term interest rates higher, crowd out private investment, and eventually pressure the Federal Reserve to intervene. If the Fed were forced to cap yields to contain borrowing costs, the adjustment could come through a weaker dollar, making these deficits one of the largest structural risks for dollar holders.
Even so, the dollar’s outlook is not straightforward.
Short-term factors, such as solid US growth, high real yields and supportive year-end seasonality, could keep it firm for now.
The longer-term outlook, however, hinges on how the Fed manages inflation, how investors interpret the end of quantitative tightening, and whether Washington restores fiscal discipline.
For now, the dollar’s decline this year appears less like a loss of confidence and more like portfolio rebalancing by international investors, many of whom have shifted toward Europe as fiscal stimulus finally takes hold after years of the US being the only major source of growth.
With the recent rebound in US growth and an end to the war in Ukraine slowing Europe’s defence spending momentum, the dollar may see a pause as global investors reassess where the next real opportunities lie.
Disclaimer: The views expressed are the opinions of the writer and whilst believed reliable may differ from the views of Butterfield Bank (Cayman) Limited. The Bank accepts no liability for errors or actions taken on the basis of this information.
Reece Jarvis is VP, Group Head of Fixed Income, Asset Management, at Butterfield.
Related Videos
