US Dollar Outlook
The US dollar’s share of global reserves is continuing to erode due to rising institutional concerns and lingering aversion to dollar exposure. According to Principal Asset Management (PAM), fears of a US recession earlier this year, driven by policy uncertainty and volatility, have weighed on the reserve currency. Although these fears proved unfounded, with growth remaining resilient, persistent hedging against the greenback suggests that investors are still cautious about holding dollars.
Factors Contributing to Dollar Weakness
PAM believes that both cyclical and structural factors suggest further weakness in the US dollar is likely. Concerns remain over the credibility and independence of US institutions, including the Federal Reserve, which has also contributed to the dollar’s demise. Additionally, as Chair Powell’s term nears its end, renewed scrutiny of Fed independence could reinforce bearish dollar sentiment. The combination of diverging global monetary paths, including the ECB nearing the end of its cuts, the BoJ hiking, and the Fed easing, points to further US dollar downside.
Gold as a Hedge
In conjunction with these cyclical and structural dynamics, gold’s surge reflects its appeal as a hedge against both US policy uncertainty and upside inflation risks. PAM notes that gold’s value has increased as investors seek safe-haven assets to protect themselves from potential economic downturns. Despite the dollar’s weakness, PAM is confident that the US dollar’s position as the world’s reserve currency is secure.
Tariffs and Inflation
Tariffs will deliver a "one-off modest inflation shock in the US", according to PAM, keeping core consumer price index (CPI) near current levels before easing slightly in late 2026. However, the risk of a more sustained inflationary episode cannot be ruled out, which may prompt the Fed to adopt a more cautious approach to easing. PAM believes that tariffs are likely to move higher as the administration shifts towards a more sector-focused approach, stabilizing above early-2025 levels but remaining well below the peaks seen after Liberation Day in April.
Economic Outlook
The US economy has proven broadly buoyant, with robust consumer spending and capital expenditures driving economic activity. AI-related investment has emerged as a significant growth engine, and PAM believes that stimulative policy could revive broader economic indicators. However, underlying vulnerabilities are forming, and the near-term picture is robust, but concerns about US institutional stability and its geopolitical posture may have structurally weakened the US dollar.
Federal Reserve Policy
In resuming its rate-cutting cycle, the Fed is responding primarily to signs of weakening labour demand. However, PAM’s chief global strategist, Seema Shah, believes that the Federal Reserve does not need to cut policy rates below neutral yet. Resilient US growth and persistent inflation pressures are likely to prevent the Fed from easing policy aggressively. PAM is anticipating a total of three 25 bps cuts this year, followed by further easing in 2026.
Global Economic Concerns
Globally, a common concern across major economies is deteriorating fiscal health, steepening yield curves, and tightening financial conditions despite rate cuts. Without serious reform, fiscal issues may weigh on long-term growth. As for equity markets, they may still have further upside, supported by policy and AI-driven capital expenditure.
Conclusion
In conclusion, the US dollar’s weakness is likely to continue due to rising institutional concerns and lingering aversion to dollar exposure. The Fed’s rate-cutting cycle and concerns about US institutional stability and its geopolitical posture may have structurally weakened the US dollar. However, the US economy remains buoyant, and equity markets may still have further upside. PAM believes that it’s key for investors to focus on balance and diversification, and opportunities may be found among second-order beneficiaries of major investment themes, attractively valued global markets, and selective private market exposures.
