Is this the end of dollar dominance?

Since the end of World War II, the US dollar has been the world’s dominant currency for the pricing of global commodities, payments in international trade, and cross-border finance and investment. That dominance has been rooted in the prudence and predictability of US policies; the safety and depth of US capital markets, especially for Treasuries; the rule of law; the dynamism of the US economy; and the nation’s strong allegiances with other Western liberal countries (Kamin and Sobel, 2024). In the view of many observers, all of these strengths now stand to be undermined by capricious and unpredictable policies, tax cuts that further widen budget deficits, assaults on the Federal Reserve, the weaponisation of law enforcement, and ruptures with US allies (The Guardian, 2025; Gensler et al., 2025; Kamin, 2025b, Reuters, 2025).

None of the administration’s actions this year has had a more visible impact on the dollar’s global stature than president Donald Trump’s announcement of huge hikes in tariffs on April 2, which he labelled “Liberation Day”. As shown in Figure 1 below, the dollar plunged even as the VIX index, a measure of financial uncertainty and volatility, soared upwards. In large part reflecting the stature of US Treasury bonds as the world’s safest and most liquid asset, the dollar has traditionally been a ‘flight-to-safety’ or ‘safe haven’ currency, and it generally rises during times of crisis. Therefore, the simultaneous rise in the VIX and fall in the dollar triggered speculation that financial markets, shocked by Trump’s disruptive announcement, had downgraded their view of US investments and started bailing out of dollar assets.

However, in the months since Liberation Day, financial markets have calmed down and the dollar has bottomed out. So, does Liberation Day mark a turning point in the global stature of the dollar, or is the failure of the dollar to act as a flight-to-safety currency more of a temporary aberration, barring future assaults by the administration on the stability of the global trade and financial system? To address this question, I estimated an econometric model of daily dollar movements in recent years and used that model to assess investor attitudes toward the dollar. To cut to the chase, investors do appear to have re-embraced the dollar, but it is unclear how long that rapprochement could last in the face of continued chaotic policy-making, out-of-control budget deficits and assaults on the bonds of co-operation with our allies and trading partners.

My analysis starts with an equation for the level of the DXY dollar index, a measure of the foreign exchange value of the dollar against a weighted average of major advanced-economy currencies. Column (1) in the table below presents results of a regression of the log-level of dollar on (1) the difference between US and a weighted average of foreign two-year Treasury yields, (2) the difference between the slope of the US yield curve (10-year minus two-year) and the weighted average of foreign yield curve slopes, and (3) the VIX. The model fits well, and the coefficients on the interest rate differentials are significant and correctly signed (see Kamin, 2025a, for details).

Figure 2 below compares the in-sample predictions of the model with the actual path of the dollar index. The model tracks the dollar reasonably well for the first four years of the estimation sample. Notably, the dollar shoots up well above the model in the months after the November 2024 election, likely reflecting the “Trump trade” in anticipation of his deregulatory pro-growth policies, and then it falls well below the model starting in February, well before Liberation Day. This suggests that even before Liberation Day, the bloom was coming off the rose regarding enthusiasm for Trump’s economic policies. The last downward jog in the actual dollar relative to prediction, even as the predicted value rebounded owing to higher Treasury yields and a surge in the VIX, was likely attributable to the investor dismay with Liberation Day and its aftermath, as noted in the introduction.

However, in the months following Liberation Day, the dollar has bottomed out while its predicted level has declined as US interest rates have fallen relative to those abroad. In consequence, the dollar is now back in line with the model’s prediction – it looks like whatever shock investors received after Liberation Day, they’ve gotten over it.

Of course, all manner of macroeconomic and financial factors can affect the dollar that are not necessarily related to investor attitudes regarding the dollar’s dominant role. A more direct indicator of investor attitudes would be the dollar’s response to volatility – that is, whether it retains its traditional behaviour as a safe haven asset (rising in response to higher volatility) or instead starts acting as a risky asset (falling as volatility rises). To hone in on this behaviour, column (2) in the table above presents estimates of a regression of the daily change in the dollar on changes in interest rate differentials, changes in the VIX, and, finally, the one-day-lagged level of the residuals from the levels model in column (1).

Figure 3 tracks the model’s coefficient on changes in the VIX, which is estimated for 30-day moving windows over the course of our four-year estimation sample. For nearly all of that sample, the estimated sensitivity was positive, indicating the dollar rose with financial volatility. However, that sensitivity shifted from positive to negative shortly after Liberation Day, eventually falling to its most negative level of the entire sample period. So, clearly, the events of Liberation Day and its aftermath exerted a profound effect on the behaviour of the dollar, shifting it from a flight-to-safety asset to a ‘risk on’ asset, such as an emerging market currency.

However, the sensitivity of the dollar to the VIX started to reverse its earlier sharp decline starting in June and has since moved back into its earlier, mainly positive range. Again, this suggests that, at least for now, markets have gotten over the shock of Liberation Day, and the dollar has reverted to its earlier safe-haven behaviour.

In conclusion, it is possible that the “risk on” episode after Liberation Day was a one-time event and that, barring future Liberation Days, the dollar will retain its status as a safe asset and dominant currency. But it could be that even as financial markets have calmed down, investors and businesses around the world are starting to reduce their dependence on the dollar for trade, payments and saving, and that it will take more time for this to become apparent. An erosion of dollar dominance is all the more likely if the US government continues to follow policies that dampen economic growth, maintain fiscal excess, threaten central bank independence and undermine global allegiances. In that scenario, the loss of dollar dominance itself would be the least of our problems.

References

Kamin, Steven and Mark Sobel (2024), “Dollar dominance is here to stay for the foreseeable future – the real issue for the global economy is how and why”, AEI Economic Policy Working Paper, January.

Graeme Wearden, “US dollar has worst first half in more than 50 years amid Trump tariffs”, The Guardian, June 30, 2025. 

Gensler, Gary, Lev Menand and Joshua Younger, “The financial sector and global dollar system”, in The economic consequences of the second Trump administration: a preliminary assessment, edited by Gary Gensler, Simon Johnson, Ugo Panizza and Beatrice Weder di Mauro, 2nd edition, CEPR Press, 2025.

Kamin, Steven B (2025b), “Dollar dominance and the Trump administration,” in The economic consequences of the second Trump administration: a preliminary assessment, edited by Gary Gensler, Simon Johnson, Ugo Panizza and Beatrice Weder di Mauro, 2nd edition, CEPR Press.

Hannah Lang, “Dollar hits three-year low as Trump attacks threaten Fed’s independence”,  Reuters, April 21, 2025.

Kamin, Steven B (2025a), “Dollar movements and dollar dominance in the aftermath of Liberation Day”, AEI Economic Policy Working Paper, June.