Are we witnessing the end of dollar dominance? For decades the US dollar has been at the centre of the global financial system. While its dominance has previously been questioned, it has never come close to being displaced. Now, however, 2025 might be the year when the “exorbitant privilege”, as said former French finance minister Valéry Giscard d’Estaing, begins to erode. Two of the defining trades of this year — the dollar’s slide and the resurgence of emerging markets — point to shifting tides in global finance.
The first story of 2025 is the dollar itself. The Bloomberg Dollar Index, which tracks the greenback against a basket of major currencies, has fallen almost 10% this year to date. This is its sharpest drop in almost two decades. The decline is broad based, given that the currency has sold off against all other major currencies including emerging markets. The rand is 8% stronger against the dollar so far in 2025. Against the traditional inflation hedge of gold, the drop is even more extraordinary; according to Bloomberg data, the US dollar is down 30% against bullion.
Oddly, this sell-off in the US currency has not coincided with a weak US equity market. Despite tumbling in April on the back of Trump’s tariff pronouncements, the S&P 500 has staged a strong rebound and is up roughly 13% year to date. Those foreigners holding US equities without an exchange rate hedge will be broadly flat for the year. This is a reality usually associated with investing in emerging markets, not the world’s pre-eminent economy.
Why hasn’t the stock market rally lifted the currency? The answer lies in how investors are allocating capital. Foreign flows into US equities remain robust, but increasingly they are arriving through currency-hedged trades.
Deutsche Bank research shows that for the first time in more than a decade, hedged inflows into the US now exceed unhedged inflows. In equities the trend is particularly stark, with an astonishing 80% of inflows this year being hedged, from virtually nil at the start of the year. This shows a structural shift; while investors still want exposure to US assets, in particular the behemoths of the Magnificent 7 large cap tech companies and other businesses exposed to AI such as Oracle, they are not willing to take the institutional risk associated with Trump’s wildcard administration.
Interest rates
What has led to this drop in value of the world’s benchmark currency? The more prosaic explanation is interest rates; the US cut rates last week for the first time in a year and indicated it has only begun its easing cycle. One would expect that the dollar would fall as a result, particularly given that other central banks have either indicated they are done with cutting (such as the European Central Bank) or that they have no intention to cut at all (such as the SA Reserve Bank).
Interest rates are only half of the story, however. Data shows that investors were hedging US dollar exposure long before the Fed signalled the shift to start cutting rates in late August at the Jackson Hole monetary policy symposium.
A weaker dollar, which is being hedged by foreign investors, suggests diminished confidence in US economic management. The surge in gold underscores that fear, as investors (including other central banks) seek protection against both future US inflation and systemic monetary instability.
This hypothesis is confirmed by the second of this year’s most critical trades; the resurgence of emerging markets. This asset class has been unloved for more than a decade. Hurt by a strong greenback, dollar-funded investors have stayed on the sidelines, preferring to stay in US markets supercharged by Covid-era liquidity gushing through the system.
Now the tide is turning. Since July, currencies like the Brazilian real, Mexican peso and even the South African rand have surged. Beijing’s firmer yuan fix, motivated in part by its desire to internationalise the renminbi and project it as a credible alternative to the US dollar, has further buoyed sentiment. With the dollar selling off, the longstanding headwind facing emerging market assets is starting to turn into a tailwind.
The trend is corroborated by equities; year-to-date the MSCI Emerging Market benchmark has far outperformed the S&P500, up 24% compared with 13% for the US market. South Africa is a case in point; the Top 40 has surged 30% this year, outpacing the US market for the first time since 2022.
Diversification also looks more compelling, purely on a valuation perspective. US equities are expensive by almost any measure, trading at all-time highs and an astonishing average price to earnings ratio of 30 times. Unless AI can truly deliver transformative gains to productivity, an increasingly doubtful claim, the S&P 500 will underperform. Against this backdrop, emerging market equities look excellent value.
Signs of realignment
Signs of realignment are increasingly evident. Some of the world’s largest fund managers are reducing exposure to US treasuries, while gold is now central banks’ biggest reserve asset, surpassing US bonds for the first time since 1996. The Bank of America’s latest investor survey shows a marked shift towards emerging market assets, reflecting both valuation appeal and scepticism over US monetary and economic fundamentals.
Emerging market bulls have said this all before. Since 2000, emerging markets like India, Indonesia and Poland have consistently outpaced US GDP growth, but their corporate earnings have lagged. Currency shocks, fiscal blowouts and political crises have periodically derailed investors and hurt returns.
But this time could be different, for two reasons. First, the US is grappling with what economists have termed “fiscal dominance”; when high government debt and deficits compel the central bank to conduct monetary policy in a way that supports government finance, rather than solely focusing on price stability. Heavy debt burdens in the US have led to persistently high debt financing costs. This, in turn, is putting pressure on central banks to cut rates, even when inflation is at elevated levels. Trump’s attacks on Fed independence is a clear example.
Second, emerging market countries have been through their fiscal crises. Many have imposed discipline, reigned in deficits and raised real interest rates aggressively to tame inflation. South Africa’s ultra-hawkish Reserve Bank is a case in point, as is the National Treasury, which has managed to run primary surpluses in SA over the past two years. The last time that happened was 2008.
The average emerging market budget deficit is 2.4%, according to Allianz Global Investors. In the US the same figure has widened to about 6.4%. This deficit has boosted US debt to GDP to a startling 124% this year. This makes emerging markets, at an average of 76% according to International Monetary Fund data, look positively frugal.
These realities are not lost on investors. The dollar itself has become a barometer of confidence in the US, with each bout of political chaos in Washington DC eroding trust and leading to a selloff in the US dollar. Emerging markets by contrast look almost stable by comparison, even if only by default.
False starts
There have been many false starts for emerging markets in the past decade. Emerging markets have seen hype before, only to falter when global conditions changed. Yet the combination of US fiscal woes, waning confidence in the dollar, and relative improvements in emerging market fundamentals make the case to invest in markets like South Africa stronger than it has been in years.
The US currency will not lose its reserve status overnight, but its supremacy no longer looks unassailable. For the first time in a generation, the dollar’s decline and emerging markets’ ascent may represent more than just another cyclical swing. It could mark the beginning of a structural reset.
If this is the case, 2025 may indeed be remembered as the year the dollar’s dominance began to wane. Investors with exposure to the US dollar should take note.
This time really might be different. DM