USD Faces Continued Pressure Amid Global Economic Shifts

The foreign exchange (FX) markets have exhibited significant volatility in recent times, particularly concerning the performance of the United States Dollar (USD). In 2025, the USD Index (DXY), which measures the value of the USD against a basket of six major currencies, recorded a notable 9.6% depreciation. This decline marks one of the worst performances for the USD in nearly a decade, with the Euro (EUR), Swiss Franc (CHF), and Pound Sterling (GBP) gaining value against it.

As the USD experiences this selloff, market analysts and investors are scrutinizing its future direction. There is currently no clear consensus. Proponents of the USD argue that it remains supported by the distinctive economic strength of the United States, which is characterized by higher productivity growth and a robust supply of high-quality assets. However, there are indications that further adjustments to the USD may be necessary.

Assessment of USD Valuation

Despite its recent decline, some analysts contend that the USD remains overvalued according to various metrics. This assessment suggests a need for more substantial long-term adjustments. A common method for evaluating currency valuation involves analyzing trade-weighted, inflation-adjusted exchange rates, known as the real effective exchange rates (REER). This approach provides a more comprehensive view than traditional FX rates, as it considers shifts in trade patterns and economic imbalances.

Data from December 2025 indicates that the USD was the most overvalued currency among advanced economies, exceeding its notional fair value by more than 17%. While the depreciation in 2025 was significant, it contributed only modestly to correcting this overvaluation. From the USD’s peak strength in January 2025, the overvaluation has only decreased by 640 basis points, accounting for less than 30% of the necessary adjustment.

Global Economic Dynamics and Investor Behavior

Several factors could influence the USD’s trajectory moving forward. One critical aspect is the evolving economic landscape of major advanced economies. In recent years, the United States has adopted more aggressive fiscal policies, pushing its deficit to approximately 7% of GDP. This has bolstered economic performance relative to peers. However, with limited capacity for further fiscal expansion, other advanced economies are beginning to adopt more expansionary measures, potentially narrowing the growth and interest rate differentials with the US.

This narrowing gap could diminish the USD’s relative advantage, favoring other currencies. Additionally, global investors are increasingly rebalancing their portfolios, which may lead to a shift away from US assets. Over the past decade, investment portfolios have become heavily concentrated in US assets, reflecting a prolonged period of strong US economic performance and equity returns. Consequently, many global investors find themselves structurally overweight in US assets, while exposure to other advanced economies remains comparatively low.

Even minor changes in global asset allocation, such as slight reductions in US exposure for diversification or risk management, could result in significant capital flows toward under-allocated asset classes. This shift would likely exert further selling pressure on the USD.

In summary, the USD is poised for potential adjustments as it moves towards more fair valuation levels. This outlook is supported by a normalization of US economic exceptionalism and ongoing portfolio rebalancing initiatives among global investors.