Dollar weakness catches investors off guard

Inflection point or just resting?

U.S. dollar weakness has caught many investors off guard this year, as the imposition of widespread tariffs was expected to lead to devaluations for U.S. trading partners’ currencies. While the greenback has clawed back some of its year-to-date losses in recent weeks, trade-weighted dollar indexes are still down over 9% at the time of writing. With its dominant role in central bank reserves, global finance and trade, getting the trajectory of the dollar right is critical. Accordingly, are we witnessing an inflection point for the U.S. dollar, or will this year’s weakness prove to be fleeting?

The long-term de-dollarization theme has received heightened attention in recent years due to the “weaponization” of the U.S. dollar, which began with the Patriot Act in 2001 and expanded with Iranian sanctions in 2012 and Russian sanctions in 2014 and 2022. Central banks have been diversifying currency composition and increasing allocations to other currencies and commodities like gold in their reserves.

Non-aligned nations have increasingly sought to trade and finance themselves in their own currencies. However, the speed of de-dollarization should not be overstated. It remains a glacial affair, as there is a severe lack of viable alternatives that have the scale to displace the dollar. The move away from the dollar should thus be viewed as a structural headwind, but will not outweigh shorter-term cyclical factors.

What’s softening the dollar?

On that front, several shorter-term forces argue for a softer dollar. Elevated U.S. policy risk has increased uncertainty about the dollar’s safe haven premium, the country’s fiscal trajectory, and the credibility of its institutions. The Federal Reserve began an interest rate cutting cycle in September, and while elevated inflation will act as a limiting factor, interest rate differentials with the Euro Area and Japan are set to contract. In addition, U.S. growth momentum is slowing relative to other developed and emerging economies (see our recent "Ask Forstrong – What’s So Special About The K-Shaped Economy?" for more insights on the U.S. economy).

When growth leadership shifts abroad, capital flows and FX positioning tend to follow. Lastly, starting points matter. Per the chart below, the trade-weighted U.S. dollar remains overvalued on an inflation-adjusted basis versus its international peers. That leaves ample room for further downwards mean reversion and currencies have a tendency to overshoot their fundamentals (both on the upside and the downside).

For investors, the practical question is how to position portfolios in a regime of dollar weakness.

Maintaining a hedge on U.S. dollar exposure is an obvious way to manage risk, but the investment implications go far beyond this “first order” effect. From a high level, a falling U.S. dollar tends to boost global liquidity, as debt burdens and dollar funding costs decline for global borrowers. Rising liquidity is a key component of global risk appetite.

From an asset class perspective, commodities historically benefit because most raw materials are priced in U.S. dollars. If a falling dollar spurs global credit growth, industrial commodities also receive a tailwind from an improving demand outlook. Emerging markets typically benefit from improved solvency, inbound capital flows, and currency appreciation. Finally, cyclical sectors such as industrials benefit through stronger demand and wider margins when commodity and export-sensitive dynamics improve.

Investment implications

Here’s a top-line summary of our current asset strategy.

Cash and Currencies. The U.S. dollar has depreciated against most major currencies this year, defying expectations that U.S.-initiated tariffs on major trading partners would have the opposite effect. If an inflection point has been reached, the U.S. dollar has considerable downside risk as it remains overvalued according to conventional metrics such as real effective exchange rates. A partial Canadian dollar hedge on U.S. assets has been increased in client portfolios.

Bonds. U.S. bond yields remain attractive on an absolute basis versus most other developed markets. The outlook for longer-term U.S. bond yields is mixed, as positive factors including ebbing growth momentum and Fed rate cuts must be weighed against fiscal profligacy concerns and imported inflation risks. U.S. bond exposure has been increased to a near-neutral level this quarter.

Equities. Smaller U.S. companies tend to be more exposed to slowing domestic growth conditions and have less pricing power to combat the impact of tariffs. A weakening U.S. dollar trend may further exacerbate input price pressures, while a higher proportion of domestic sales is a disadvantage relative to large-cap peers. We have liquidated U.S. mid-cap equity exposure in client portfolios, awaiting a better entry point.

Opportunities. Gold prices have been supported by rising central bank purchases, a weak U.S. dollar, and heightened geopolitical risk. Gold remains a critical portfolio diversifier and tail risk hedge, but has become overheated in the short-term relative to most other commodities. We have elected to take some profits and trim exposure to gold in growth-oriented strategies this quarter; however, we remain structurally positive on the metal.

Visit the Forstrong Insights page to stay informed on our global macro thinking and strategy updates.

David Kletz, CFA, is Vice President and Lead Portfolio Manager at Forstrong Global Asset Management. This article first appeared in Forstrong’s Insights Blog. Used with permission. You can reach David by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at dkletz@forstrong.com.

Disclaimers

Content © 2025 by Forstrong Global. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. Used with permission.

The foregoing is for general information purposes only and is the opinion of the writer. The author and clients of Forstrong Global Asset Management may have positions in securities mentioned. Performance statistics are calculated from documented actual investment strategies as set by Forstrong’s Investment Committee and applied to its portfolios mandates, and are intended to provide an approximation of composite results for separately managed accounts. Actual performance of individual separate accounts may vary with average gross “composite” performance statistics presented here due to client-specific portfolio differences with respect to size, inflow/outflow history, and inception dates, as well as intra-day market volatilities versus daily closing prices. Performance numbers are net of total ETF expense ratios and custody fees, but before withholding taxes, transaction costs and other investment management and advisor fees. Commissions and management fees may be associated with exchange-traded funds. Please read the prospectus before investing. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

Image: iStock.com/Pla2na