The US Dollar Isn’t Dying, It’s Getting Reprice

The U.S. Dollar Index (DXY) has fallen sharply in 2025, down roughly 8% ytd. For some, this decline signals a collapse in global confidence in the dollar. Social media feeds are filled with pronouncements that the dollar is being rejected, that investors are fleeing Treasuries, and that America is on the cusp of a monetary reckoning. But this interpretation is not just exaggerated it's analytically flawed.

Understanding the DXY: A Narrow Lens

The DXY is not a comprehensive measure of dollar strength. It is a legacy index that gives disproportionate weight to the euro (58%), yen (14%), and pound (12%). It entirely omits key US trade partners like China, Mexico, Canada, South Korea, and Brazil. So when DXY falls, it often means that the EURO and YEN are strengthening, not that the USD is collapsing.

And that is exactly what's happening in 2025. The EURO has rallied on the back of looser fiscal policy and persistent inflation in the Eurozone. Japan has begun exiting its ultra loose monetary regime, causing the yen to rebound. These developments have dragged the DXY lower. But if you look at the Fed’s broad trade weighted dollar index, the picture is much more stable. The dollar remains elevated versus a wide range of emerging markets and trade partners.

Source - FRED

The chart below also illustrates the relative shift in global monetary policy regimes. As Japan exits its ultra-loose monetary policy and German bund yields rise alongside US yields, interest rate differentials between the US and its major peers are narrowing. This tightening in differentials boosts demand for the YEN and the EURO relative to the USD. Because the DXY is heavily weighted toward the euro (57.6%) and Japanese yen (13.6%), this appreciation of both currencies mechanically pulls the index lower. In other words, even if the dollar remains strong or stable against most other global currencies, such as the Chinese yuan, Mexican peso, or emerging-market FX, the DXY will still fall if the EURO and YEN strengthen. This is not necessarily a sign of broad dollar weakness or loss of confidence, but rather a function of how the index is mathematically constructed. As a result, recent moves in the DXY reflect relative policy normalization abroad rather than a structural rejection of the dollar.

Foreign Demand for Treasuries Is Shifting, Not Evaporating

Foreign treasury demand also affects the demand for USDs. The US is facing a growing Treasury absorption challenge. According to the Treasury Borrowing Advisory Committee (TBAC), privately held net marketable borrowing will exceed $2.2tril in FY25. Foreign official demand, particularly from China and Japan, has slowed. Primary dealers and domestic institutions are absorbing more issuance. Auction tails are widening, and real yields are rising. These are signs of market recalibration not collapse.

Source - TBAC 2025

This chart highlights the decline in foreign participation in long end Treasury auctions, with primary dealers and domestic investment funds taking a larger share of the burden. It visually confirms the shift from passive foreign absorption to more price sensitive domestic financing. This shift reflects the end of an era where foreign buyers would passively absorb US debt regardless of price but its not a structural unwind of the global dollar system. This shift matters for the dollar because as foreign institutions step back from Treasury markets, they also reduce their need to accumulate or hold dollars, leading to lower structural USD demand at the margin. In the short term, this contributes to downward pressure on the dollar, especially when paired with large net issuance and deteriorating fiscal dynamics. Since these foreign flows have historically supported both Treasury valuations and the USD exchange rate, their retreat, even if orderly, triggers a recalibration in global portfolios, including reserve managers, pension funds, and global bond funds.

This transition marks the MILD end of the “exorbitant privilege” era where the US could issue debt freely without impacting its currency or yield curve. But it is not a collapse. Rather, it is a repricing of US duration risk and a re-balancing of global capital allocation, where investors, both foreign and domestic, now require higher term premia to absorb US debt. This repricing weighs on the dollar in the short term (mechanically affecting DXY), but it reflects a healthier, more transparent cost of capital, not a wholesale rejection of the dollar or US assets.

Source - NY FED

A Weaker Dollar May Help Rebalance Trade

Contrary to collapse narratives, a weaker dollar could actually help the US economy. Fed models estimate that a 10% real depreciation improves the US trade balance by about 1% of GDP.

Source - US FED

Deutsche Bank suggests that reversing the 40% real dollar appreciation since 2009 could erase the trade deficit entirely, especially when paired with tariffs and reshoring policies.

For years, the US system became overstretched i.e. running large fiscal and trade deficits while expecting passive foreign capital to fund both at low yields and a strong dollar. That trifecta is no longer sustainable particularly in a bifurcated world (China's rise and export dominance). A weaker dollar is not a collapse, it’s a necessary repricing that encourages import substitution and boosts export competitiveness while taking concern of US national security needs. While the trade deficit has widened in early 2025, possibly due to front loaded imports ahead of tariffs, the dollar adjustment mechanism is in motion, and its effects may take several quarters to materialize.

The dollar is not collapsing. It is undergoing a repricing. Treasury markets are adapting to new supply dynamics. Currency markets are adjusting to changing global rate differentials. And investors are reevaluating the dollar’s role in light of evolving fiscal and geopolitical realities. The DXY is falling. But that is not a verdict on the dollar's demise. It is the beginning of a new equilibrium, one where dollar dominance is no longer free, but still very much intact.