Another day, another dollar: US dollar dominance?

As the US stock market dominates global equity indices, so does the US dollar dominate currency markets. The US has been home to the world’s major stock market since early in the twentieth century and the US dollar has been the global currency of choice for almost as long. Matt Brennan, Head of Asset Allocation, considers the position of the US dollar and what this could mean for the country’s equities.

The US dollar’s supremacy comes through in several ways, including its use as the main foreign exchange reserve for central banks globally. Effectively this means it is considered a solid store of value in case of a financial shock. The dollar’s use has continued through the years given the relative strength and stability of the US market and US economy, as well as the perception of its stable rule of law and promotion of free trade. Global financial markets and central banks were confident that this robustness would continue over the long term and so the US dollar’s relative value could be relied upon. As at the end of the first quarter 2025, the US dollar accounted for just shy of 58% of the total of foreign exchange reserves held by central banks globally.¹

The US dollar has also been the chief currency for global trade for many years. As such, it is used in commodity trades and the majority of foreign exchange transactions. Additionally, it has been a common anchor point for less-stable currencies via currency peg systems, like that used by Saudi Arabia because of the importance of dollar-traded energy commodities for its economy.

After a strong performance run, the US dollar has slipped back this year relative to a basket of currencies.

This dominant position has led to a high global need for US dollars through the years, and in turn, this has helped to generate a level of rolling demand for US Treasury bonds. Arguably, this bond demand has bolstered the overall stability of the dollar in something of a self-sustaining cycle. Additionally, this interest in US government debt has likely helped US interest rates to generally remain lower than they might otherwise have been, providing US consumers and businesses the opportunity to tap into broadly cheaper finance.

After a strong performance run, the US dollar has slipped back this year relative to a basket of currencies. On an individual basis, it has weakened against sterling and the euro through the nine months to September, for example. There could be several reasons for this. The standing of the US both economically and politically and trust in the dollar has arguably ebbed amid concern about the future independence of the US central bank, the Federal Reserve (Fed). Additionally, with the US tariff-related uncertainty and the likelihood of this hindering global trade flows, demand for dollars may have declined. At the same time, the price of gold has hit all-time highs, potentially because it has benefitted from switching from the dollar.

Perhaps running in tandem with some of the other reasons for dollar underperformance is Stephen Li Jen’s Dollar Smile Theory². This says that the US dollar tends to be particularly strong when optimism is high amid strong economic growth. At the other extreme, the theory says the dollar often performs well when growth is low, and markets and businesses are pessimistic, as there is a focus on reducing risk and seeking safe-haven assets. Between these two poles, the dollar is weaker, there is less demand for US assets and the currency wilts. It could be argued that the US economy is neither running hot nor cold at the moment and the dollar has therefore suffered as a result.

In recent years, the dollar’s role at the centre of the world currency system has come under greater scrutiny and its primacy more regularly questioned.

In recent years, the dollar’s role at the centre of the world currency system has come under greater scrutiny and its primacy more regularly questioned. Over the longer-term, international developments have helped to showcase increasingly credible alternatives to the dollar. For example, the euro, which accounts for around 20% of reserves globally, and the yuan, which is used by some South American countries to trade internationally, could see increased positions in reserves and currency systems. This recent underperformance and developments in the US this year could serve to reinforce this trend, and over the long term, threaten the dollar’s position at the pinnacle of currency reserves.

The direction of the dollar has a knock-on importance for US equities. The relationship between the two quite consistently demonstrates positive correlation – when one does well, so does the other. However, over the longer term, it has not always been easy to say which has had greatest influence in this relationship. Indeed, so far this year, despite US-dollar weakness, the US equity market has still generated robust absolute gains, in local currency terms, helped by technology growth and the AI theme.

We will remain watchful for further erosion of the US dollar and reduced confidence in the currency, and whether this could feed through to US equities. Similarly, if the US market comes off the boil, will it stoke a further bout of dollar weakness?

¹International Monetary Fund, data.imf.org, IMF Data Brief: Currency Composition of Official Foreign Exchange Reserves, 17th July 2025
²Stephen Li Jen and Fatih Yilmaz, The Dollar Smile, Morgan Stanley, 2001