The U.S. Dollar at a Crossroads: Fair Value, Macroeconomic Imbalances, and Strategic Rebalancing in a Fragmented World

The U.S. dollar, long the bedrock of global finance, now faces a pivotal juncture. In 2025, its traditional safe-haven status has faltered, with uncharacteristic weakness observed even during periods of global risk aversion. This divergence from historical patterns reflects a confluence of macroeconomic imbalances, shifting capital flows, and structural challenges to U.S. dominance. For investors, the implications are clear: the dollar’s fair value is under reassessment, and strategic positioning must adapt to a world where diversification and hedging are no longer optional.

A Dollar Overvalued, but Anchored by Legacy

Valuation models such as purchasing power parity (PPP) and the Goldman Sachs Dynamic Equilibrium Exchange Rate (DEER) suggest the U.S. dollar remains overvalued in 2025, despite its early-year depreciation [1]. The DEER model, which incorporates long-term fundamentals like productivity and terms of trade, indicates the dollar has not fully adjusted to external imbalances, including persistent U.S. budget deficits and fiscal sustainability concerns [1]. Meanwhile, PPP gaps highlight stark divergences: China’s GDP, for instance, doubles in PPP terms compared to nominal dollar valuation, underscoring the dollar’s overvaluation relative to emerging markets [2].

Yet, the dollar’s overvaluation has not triggered a sustained downtrend. Historical precedent shows that valuation alone is insufficient without macroeconomic catalysts—such as policy shifts, recessions, or geopolitical shocks—to realign exchange rates [1]. The recent April 2025 tariff announcement, dubbed “Liberation Day,” exemplifies this dynamic. Contrary to expectations, the broad tariffs led to a sharp depreciation of the dollar against G10 currencies, as advanced economies redirected capital away from U.S. assets [3]. This event, coupled with a spike in global uncertainty (reflected in the VIX index and falling oil prices), underscores how policy-driven volatility can amplify currency mispricing risks [3].

Macroeconomic Imbalances and Erosion of Confidence

The dollar’s challenges are rooted in broader macroeconomic imbalances. The U.S. fiscal outlook remains precarious, with Moody’s downgrade of U.S. sovereign debt in May 2025 exacerbating concerns over institutional credibility [1]. Global growth projections, while modestly positive, are clouded by trade tensions and tightening financial conditions. The OECD forecasts U.S. GDP growth at 1.1% in 2025—well below the global average of 2.9%—highlighting the relative underperformance of the world’s largest economy [2].

Meanwhile, non-U.S. markets are gaining traction. European fiscal stimulus, including Germany’s infrastructure investments, and Japan’s NISA reform, which redirects household savings into equities, have created fertile ground for international capital flows [4]. Non-U.S. equities have outperformed U.S. counterparts in 2025, with year-to-date returns of 11.2% driven by favorable trade policy dynamics and redirected trade flows [4]. These trends challenge the “TINA” (There Is No Alternative) narrative that once underpinned dollar dominance.

Strategic Positioning in a Fragmented Capital Landscape

For investors, the shifting landscape demands a recalibration of asset allocations. The erosion of the dollar’s edge—its share of global central bank reserves has fallen from 71% in 1999 to 57% in 2025—signals a long-term structural shift [5]. Strategic positioning must now account for:
1. Diversification into non-U.S. assets: With international equities projected to deliver 7.3% long-term returns and emerging markets at 8.4%, capital is increasingly flowing to regions offering better risk-adjusted returns [4].
2. Hedging against dollar volatility: The dollar’s uncharacteristic behavior in risk-off scenarios necessitates hedging strategies to mitigate exposure to sudden swings.
3. Reassessing safe-haven allocations: Gold and other non-dollar assets are gaining traction as alternatives to U.S. Treasuries, which face higher borrowing costs amid fiscal uncertainty [5].

The implications extend beyond portfolios. A weaker dollar could increase currency hedging costs for global trade participants and reduce the efficacy of dollar-based financial sanctions in U.S. foreign policy [5]. For emerging markets, the dollar’s overvaluation presents both opportunities (cheaper access to U.S. goods) and risks (capital outflows and currency volatility).

Conclusion: Navigating the New Normal

The U.S. dollar’s fair value in 2025 is a tale of contradictions: overvalued by traditional metrics yet resilient due to its entrenched role in global finance. While macroeconomic imbalances and policy uncertainties persist, the path forward hinges on whether structural reforms can restore U.S. competitiveness or if the world will accelerate its shift toward a multipolar currency system. For now, investors must balance the dollar’s lingering dominance with the realities of a more fragmented and dynamic global capital landscape.

Source:
[1] US Dollar's Shifting Landscape: From Dominance to Diversification [https://am.gs.com/en-us/advisors/insights/article/2025/dollars-shifting-landscape-from-dominance-to-diversification]
[2] OECD Compendium of Productivity Indicators 2025 [https://www.oecd.org/en/publications/oecd-compendium-of-productivity-indicators-2025_b024d9e1-en/full-report/cross-country-comparisons-of-labour-productivity-levels_b2fdb493.html]
[3] Tariffs, the dollar, and equities: High-frequency evidence [http://cepr.org/voxeu/columns/tariffs-dollar-and-equities-high-frequency-evidence-liberation-day-announcement]
[4] 2025 Q3 Capital Market Assumptions [https://www.pgim.com/us/en/institutional/insights/asset-class/multi-asset/quantitative-solutions/2025-q3-capital-market-assumptions]
[5] Is the Dollar Losing Its Edge? [https://econofact.org/is-the-dollar-losing-its-edge]