The Dollar's Dominance: A Fragile Exorbitant Privilege?

The U.S. dollar's reign as the world's primary reserve currency has long been a pillar of global finance, underpinning the “exorbitant privilege” that allows the United States to fund its deficits at historically low costs. Yet recent trends—shrinking foreign Treasury holdings, rising non-dollar alternatives, and geopolitical shifts—are testing this dominance. For investors, the question is clear: Is the dollar's supremacy eroding, and what does that mean for U.S. Treasury bonds?

The Dollar's Declining Grip on Reserves

The International Monetary Fund's COFER data paints a nuanced picture. While the dollar's share of allocated reserves edged up to 57.8% in late 2024, this was driven by currency fluctuations rather than a structural shift. Underlying trends reveal a steady decline from its 2000 peak of 71%, with non-traditional currencies like the Canadian dollar (now at 2.77%) and Chinese renminbi (2.18%) nibbling at its margins.

.

The true threat lies in foreign central banks' reduced appetite for U.S. debt. China, Russia, and others have pared their Treasury holdings, with Russia's holdings dropping from $81 billion in 2018 to just $15 billion today. This exodus, driven by geopolitical tensions and diversification strategies, signals a gradual loss of faith in the dollar's safety net.

Treasury Bonds: A Safety Net or a Risky Gamble?

The U.S. Treasury market—$27.4 trillion in size—remains the world's deepest and most liquid. However, risks are mounting:
- Yield Pressures: The 10-year Treasury yield has hovered near 4.4%, with a critical threshold at 4.8%. A sustained breach could trigger a selloff, hurting bond prices and amplifying financial stress. The term premium—the extra yield investors demand for fiscal and inflation risks—has climbed to +0.8%, signaling growing unease.
- Fiscal Overreach: The proposed “Big Beautiful Bill” tax plan threatens to add $1.7 trillion to deficits by 2034, requiring massive Treasury issuance. This could strain demand unless the Fed or regulators (e.g., easing bank leverage rules) step in.
- Foreign Flight: Foreign investors hold $7.5 trillion in U.S. assets, but repatriation flows and FX hedging are already pressuring the dollar. A weaker greenback could accelerate outflows, squeezing Treasury prices.

Opportunities in the Fraying Hegemony

The dollar's decline isn't all doom for Treasury investors—yet. Structural advantages endure:
- Liquidity and Depth: The U.S. market's unmatched size ensures Treasuries remain a refuge in crises, even as gold and euros gain traction.
- Currency Pegs: Over 38 countries still peg their currencies to the dollar, anchoring demand for U.S. debt.
- Alternatives' Limitations: The eurozone's fragmentation and China's capital controls hinder the renminbi's rise, preserving the dollar's role as a “least worst option.”

For investors, the path forward requires balancing these factors:
1. Short-Duration Treasuries: Opt for maturities under 5 years to mitigate rising yield risks.
2. Diversify Globally: Shift a portion of bond allocations to higher-yielding European sovereigns (e.g., Germany's bunds) or emerging market debt, which may benefit from dollar weakness.
3. Hedge Currency Risks: Use futures or ETFs (e.g., FXE for euros) to offset potential dollar declines.

The Bottom Line: A Fragile, but Still Dominant, Privilege

The dollar's hegemony is fraying at the edges, but its collapse is unlikely in the near term. Investors should treat Treasuries as a core holding but temper exposure with global diversification. The “exorbitant privilege” remains intact—for now—but the calculus for Treasury investors is shifting. Stay vigilant, and prepare for a world where the dollar's reign, while enduring, is increasingly contested.

Jeanna Smialek is a financial analyst specializing in global macroeconomic trends and currency dynamics.