The trigger was a US-centric policy shock that reverberated across all asset classes, fundamentally altering long-standing market relationships and calling into question the US dollar’s role as the ultimate safe harbor.

Since April 2025, the US dollar has sharply declined approximately 10-11 percent, its worst start to a year since 1973. What has particularly unsettled markets is the unusual nature of this decline. Normally, a risk sell-off supports a stronger dollar on a safe-haven bid. However, recent price movements have defied this expectation, as shown in Figure 1. Despite a broad risk asset sell-off, both bonds and the dollar weakened, mirroring conditions observed during the United Kingdom’s debt crisis in 2022.

Is the unusual behavior a reflection of disenchantment and dislodgement of US assets and a reversal of the hegemonic role of the dollar? Or is it a temporary dislocation driven by recent policy shifts? Recent currency and asset flows provide meaningful clues.

As documented by the Bank of International Settlements, high-frequency data shows that more than 60 percent of the dollar’s recent decline occurred during Asian trading hours. However, this analysis revealed no meaningful outflows from US assets. With nearly $37 trillion of US-based assets held in foreign hands,¹ weakness in the USD has triggered an urgent need among asset owners to hedge previously unhedged exposures. Flow data confirms that foreign investors retained their US holdings, but actively layered currency hedges atop those positions to protect them from currency depreciation. Thus, the dollar’s decline can be understood as a flow-driven adjustment — a hedge-cost shock interacting with fiscal credibility concerns — rather than a wholesale reassessment of US asset quality.

This distinction matters. Flow-driven episodes tend to be sharp, yet reversible, once positioning normalizes. Structural re-ratings, by contrast, fundamentally alter long-term expectations. The key question is whether hedging flows will subside quickly and normal relations resume, or whether we are on the cusp of a structural re-rating of foreign interest in US assets.
 

Drivers of the recent decline

It is our view that the recent fall in the dollar was not a single-cause event, but the product of three reinforcing mechanisms that interacted in real time. First, an endogenous hedging loop emerged once the dollar began to weaken after the April “Liberation Day” tariff announcement. A strong dollar and rising hedging costs had previously deterred currency hedges; however, the initial price shock shifted the cost-benefit calculation. Asian life insurers and pension funds — already holding record-high allocations to dollar assets — responded by layering forward contracts on top of unhedged bond portfolios. Importantly, these flows peaked during local trading hours, underscoring the self-reinforcing nature of the move, the weaker the dollar traded in Asia, the stronger the incentive to hedge, generating further depreciation pressure.

Second, tariff-induced trade front-loading removed a critical source of natural dollar demand. In Q1 2025, imports spiked 41 percent on an annualized basis as companies rushed to secure input goods before levies took effect.² The financing of these shipments required firms to exchange dollars for foreign currency, temporarily swamping the FX market with supply. As inventories were built ahead of tariffs, subsequent quarters may record lower import volumes depending on the strength of the economy and improvement of consumer sentiment. The result is a time-shifted pattern of dollar weakness that may linger until inventories normalize and tariff pass-through becomes visible in consumer prices.

Finally, and importantly, fiscal optics altered currency’s risk-reward profile. Rising policy uncertainty has resulted in an emerging fiscal risk premium. As witnessed after Liberation Day, markets marked down the dollar even as US yields rose — a combination last encountered during the UK mini-budget crisis of 2022. The confluence of a historic unilateral hike in tariffs and discussions of possible tax hikes on foreign holders of US securities³ have eroded the hegemonic premium of US assets (starting with the dollar). This reflects a growing perception that US policymakers may be underestimating the strategic value of US capital market openness, and implies that waning structural confidence became the marginal price driver.

Collectively, these mechanisms demonstrate that the dollar’s depreciation was neither purely cyclical — driven by technical factors or idiosyncratic parts of the market — nor purely structural, driven by erosion of faith in US markets. It was the product of short-term flow dynamics colliding with longer-term credibility questions. Understanding this interaction is critical for forecasting whether the weakness represents a regime shift or a transitory dislocation.
 

Structural strengths and emerging vulnerabilities

Undoubtedly, the US continues to enjoy unrivalled advantages in scale, liquidity and institutional depth. The dollar anchors 58 percent of global FX reserves, facilitates 45 percent of SWIFT payments, and sits at the core of a US$130 trillion OTC FX derivatives ecosystem (BIS, 2025). These pillars have historically insulated the currency from episodic policy errors. Yet, recent events expose two qualitative vulnerabilities that merit closer attention.

The first is the erosion of policy predictability. Tariff reversals and the mere contemplation of taxing foreign portfolio flows have pushed US policy uncertainty indices to unprecedented levels. For reserve managers and long-duration investors, policy coherence is essential for maintaining unhedged exposure. While coherence frays, the logical response is to purchase insurance — in this case, FX hedges — thereby amplifying the very depreciation that prompted the uncertainty premium.

The second vulnerability is a potential decline in the core attraction of dollar-based assets. Historically, both US-based assets and the US dollar have been attractive due to robust growth and well-managed inflation, resulting in higher real yields. Today, the equation is different. On a hedged basis, nominal 10-year US Treasuries now yield 50 basis points (bp) less than German Bunds and 90 bp less than Japanese Government Bonds, undermining their relative appeal. If inflation expectations in the US remain elevated due to policy uncertainty and other reasons, then the comparative advantage of US-based assets will diminish. Put differently, structurally higher inflation in the US — absent commensurate growth relative to other countries — will remove the core attraction of US-based assets as well as the USD.

Taken together, these vulnerabilities suggest that dollar exceptionalism is evolving from an automatic privilege to a policy-contingent asset. Preserving its status will require a clearer fiscal trajectory and a more consistent strategy.

Although the dollar’s foundational strengths remain intact, recent events have reignited both the rhetoric and action that may accelerate the gradual decline of its global primacy. The policy risk premium is structural and will necessitate enhanced hedging sophistication, robust scenario analysis for unconventional counterfactuals, and proactive policy engagement.

US exceptionalism is not dead — it has become a policy-contingent asset.