Neutralgeneralactive

US Dollar Weakening as Central Banks Diversify Reserves

Rising fiscal deficits, shifting global trade patterns, and central bank gold purchases suggest a structural weakening of the US dollar. Analyze implications for international equities, commodities, and emerging market debt.

Conviction:
6/10
By:Tate Steele
Updated February 16, 2026

Rates Research

(1 entry)
Bearish0-5 Year
Confidence: 7/10|Conviction: 5/10
The dominant theme for 2026 is two-way volatility with a downward bias, with gradual USD softness likely as US interest rates are cut, though periods of dollar strength remain possible. Over a 5-year horizon, this thesis has modest merit but faces significant headwinds that constrain a structural collapse scenario. Major investment banks including Citi, Morgan Stanley, and Goldman Sachs forecast the Fed will cut rates by a cumulative 50 basis points in the first half of 2026, with the total reduction for the year potentially reaching 75-100 basis points. This rate differential compression is the primary mechanical driver of USD weakness. However, the US dollar is not "in trouble" by default—the Fed is not racing to zero, US yields remain high, and the dollar still dominates reserve holdings even as diversification continues slowly. The base case (60% probability) is gradual dollar depreciation as rate differentials compress; a bullish USD scenario (25% probability) reflects persistent inflation or geopolitical shocks reigniting safe-haven demand; a bearish USD scenario (15% probability) involves strong global growth and decisive Fed easing. Central bank diversification is real but measured: central banks now hold a larger share of reserves in gold than in U.S. Treasuries, marking the first time in decades that central banks hold more reserves in gold than in U.S. Treasuries, signaling greater questioning around dollar hegemony and rising demand for geopolitical hedges. However, gold reserve accumulation is generally not associated with de-dollarization of international reserves at the country level except in a few prominent cases—most countries pursue modest diversification that does not solely target a reduced dollar share. For rates positioning, the thesis offers tactical opportunities but limited conviction over 5 years.

Key Data Points

indicator: US Dollar Index (DXY) - Current Level
value: 97.07 as of February 16, 2026
source: Trading Economics, February 16, 2026
implication: The DXY rose to 97.07 on February 16, 2026, but has weakened 2.34% over the past month and is down 8.92% over the last 12 months. Near-term volatility masks longer-term softening bias.
indicator: Federal Funds Rate Trajectory 2026
value: Expected 75-100 bps cuts in 2026; rates toward 2.5-3.4% by year-end
source: Morgan Stanley, Goldman Sachs, Citi (January 2026); Federal Reserve Kansas City
implication: The Fed is likely to reduce interest rates from the current range of 5.25%-5.5% to as low as 2.5% by the end of 2026, and because rate differentials are a fundamental driver of currency strength, the more US interest rates fall to match the levels of its peers, the more likely it is that the dollar will weaken.
indicator: US Federal Debt & Deficit
value: Federal debt: $37.6T (Sept 2025); FY2025 deficit: $1.8T; FY2026 projected deficit ~5.8% of GDP
source: GAO (January 20, 2026), Treasury Department, Congressional Budget Office (February 2026)
implication: Federal debt was $37.6 trillion as of September 30, 2025—up $2.2 trillion from FY 2024, with interest on the debt increasing to $1.2 trillion. The CBO projects the deficit for fiscal 2026 will be about 5.8% of GDP, about where it was in fiscal 2025. Rising fiscal burden pressures reserve currency status but does not trigger immediate de-dollarization.
indicator: Central Bank Gold Accumulation
value: 1,000+ tonnes annually for 3 consecutive years (vs 400-500t historical average)
source: World Gold Council (2025), Amundi Research (October 2025), Wisdom Tree (September 2025)
implication: Central banks have accumulated over 1,000 tonnes of gold in each of the last three years, up significantly from the 400-500 tonnes average over the preceding decade, marked acceleration in the pace of accumulation against a backdrop of geopolitical and economic uncertainty. 95% of central banks anticipate an increase in global gold reserves, with 43% planning to increase their own holdings, particularly pronounced among emerging markets (48%) vs advanced economies (21%).
indicator: Dollar Share of Global Reserves
value: 56.92% as of Q3 2025 (vs 57.08% Q2 2025)
source: IMF COFER Release (Q3 2025); EBC Financial Group (December 2025)
implication: The IMF's COFER release for Q3 2025 shows the dollar share of disclosed global reserves at 56.92%, slightly below the 57.08% in Q2, with the IMF noting the share is "little changed" after adjusting for exchange rates. Reserve diversification is gradual, not structural collapse.
indicator: Emerging Market Debt Outlook 2026
value: EM growth 3.9% projected; local currency debt expected to outperform
source: State Street Global Advisors (January 2026), PineBridge Investments, William Blair (January 2026)
implication: The combination of rate cuts, central bank credibility, and a weaker USD will continue to be key in driving local currency debt returns, with EM currencies remaining undervalued versus the dollar. The US dollar remains in overvalued territory, and EM currencies are expected to perform well against the dollar and currencies of other developed markets.
indicator: Commodity & International Equities Backdrop
value: USD weakness supportive for commodities (esp. gold); EM equities positioning positive
source: Amundi Research (October 2025), VanEck (2025), Multiple EM debt houses
implication: Supportive factors for gold prices include structural demand for diversification by global investors, geopolitical uncertainties, and central banks' reserve diversification at a time of dollar weakness, with expectations of Fed rate cuts and a weak dollar as supporting factors.
indicator: International Equity Implications
value: US exporter earnings boosted; international relative valuations benefit from USD weakness
source: Morgan Stanley, Goldman Sachs, institutional strategists (2025-2026)
implication: A weaker dollar can boost the earnings of US multinational companies by increasing the value of overseas revenues when converted back into dollars, while also enhancing the appeal of international markets through favourable exchange rate effects.
indicator: 2026 DXY Price Forecasts (Consensus Range)
value: 92-98 (most forecasts), with year-end bias toward low-90s
source: Cambridge Currencies (February 2026), Long Forecast, market consensus
implication: Most forecasts cluster between 92 and 98, with year-end bias toward the low-90s, though intra-year volatility could produce brief spikes to 100+ or dips to 90 during high-volatility periods.
indicator: Rate Differential Risk (US vs Euro/Japan/UK)
value: US rates falling faster than peers; ECB/BoE holding steady or cutting more cautiously
source: Multiple FX strategists (January-February 2026)
implication: In GBP/USD, relative policy differences matter more than absolute rate levels: US rates are expected to fall faster than UK rates through 2026, with the Bank of England likely to cut more cautiously than the Fed, narrowing yield gaps in sterling's favour as Fed easing accelerates.
indicator: Geopolitical Risk / Reserve Diversification Concerns
value: 96% of central banks view US tariffs as major geopolitical concern; over 80% have geopolitics in top 3 factors
source: OMFIF Global Public Investor Survey (June 2025)
implication: 96% of reserve managers view US tariffs as a major geopolitical concern, with over 80% of reserve managers having geopolitics in their top three factors shaping longer-term investment decisions.

Sources

February 16, 2026

Credit Research

(1 entry)
Bearish0-5 Year
Confidence: 7/10|Conviction: 6/10
The federal government ran a deficit of $1.8 trillion in fiscal year 2025, and the Congressional Budget Office projected that federal deficits will exceed $2 trillion annually over the next decade. This unsustainable fiscal backdrop creates structural headwinds for the US dollar. However, the thesis overstates the pace and magnitude of dollar weakness. While the US Dollar Index continued its downward trend from 2025, officially breaking below the key 97.0 level and reaching a low of 95.5, marking a nearly four-year low since February 2022, and net central-bank gold purchases more than doubled, surpassing 1,000 tonnes on a yearly basis, primarily driven by central banks in Asia, including those of China, India, and Japan, the dollar's fundamental structural weakness is moderated by persistent yield advantage and a lack of viable alternatives. The central bank reserve diversification narrative is real but limited in scale: global central bank gold holdings amount to nearly 36,200 tonnes and account for almost 20% of official reserves, up from around 15% at the end of 2023, while the US dollar's dominance in global reserves is slowly declining, decreasing from over 70% in 2000 to around 58-59% by 2024. More critically, gold reserve accumulation is generally not associated with de-dollarization of international reserves at the country level, except in a few prominent cases, and gold purchases are more consistent with most countries pursuing a modest diversification of international reserves that does not solely target a reduced dollar share. The 5-year outlook reflects a "weaker but resilient" dollar: the US dollar in 2026 is best described as weaker, but resilient, with trend gradual downside with DXY likely ending 2026 in low-to-mid 90s, though this weakness is gradual and volatile. For credit markets, the implication is mixed: dollar weakness boosts emerging market local-currency debt returns, but the fiscal deterioration creates structural credit risks for US sovereign credit and suggests higher long-term Treasury yields, which constrains IG and HY spreads globally.

Key Data Points

indicator: US Federal Fiscal Deficit (FY2025)
value: $1.8 trillion (5.5% of GDP for FY2026 projected)
source: Congressional Budget Office; GAO
implication: Structurally unsustainable fiscal path weakens dollar medium-term, but near-term deficit stabilization (down 2% YoY) suggests policy traction; interest costs now $1.2T annually (up from $882B in FY2024), creating fiscal fragility.
indicator: Central Bank Gold Purchases
value: 1,000+ tonnes annually (2022-2024 avg); emerging markets +24% H1 2025 vs 5-yr average
source: Amundi Research; World Gold Council; Federal Reserve; J.P. Morgan
implication: Diversification trend real but concentrated in Russia, China, Turkey, India; does NOT constitute broad-based de-dollarization. Fed research finds gold purchases orthogonal to dollar reserve reduction for most countries—primarily geopolitical hedge & sanctions risk.
indicator: US Dollar Index (DXY) Performance
value: Fell 10.1% in 2025 (worst H1 since 1973); January 2026 low 95.5; consensus outlook DXY 92-102 through 2026
source: Cambridge Currencies; TradingKey; Morgan Stanley; Goldman Sachs; J.P. Morgan
implication: Dollar weakness structural but not catastrophic: Fed rate cuts (75bp in 2025, ~50bp projected for 2026) driving relative yield compression. Baseline: 3-5% further DXY decline through 2026, with high volatility and periodic rallies on risk-off.
indicator: Federal Reserve Monetary Policy Path
value: Three 25bp cuts executed in 2025; current range 3.25%-3.50%; ~2 more cuts projected through 2026
source: Federal Reserve FOMC projections; BlackRock; Morgan Stanley
implication: Dovish pivot is primary driver of dollar weakness. However, US rates remain higher vs peer central banks (ECB ~2%, BoE ~4.75%, BoJ ~0.5%), providing yield anchor that limits dollar downside risk. Inflation persistence could halt easing cycle mid-2026.
indicator: US Credit Quality & Debt Sustainability
value: Federal debt $37.6T (end FY2025); net interest spending $1.2T annually; debt-to-GDP projected to reach 106% by 2027 (vs 99% in 2024)
source: GAO; Treasury; CBO; S&P
implication: Medium-term credit deterioration risk for US sovereigns and USD-denominated credit instruments. While downgrade risk remains low (AAA maintained), term premium expansion likely—long-duration Treasury yields structurally higher. IG credit spreads vulnerable to widening if fiscal-concern narrative gains traction.
indicator: Emerging Market Debt Performance & Spreads
value: EM hard-currency debt returned 14.3% in 2025 (JPM EMBI Global); spreads at record tight levels (investment grade); HY spreads compressed 41bps Q3 2025
source: State Street Global Advisors; J.P. Morgan; Morgan Stanley
implication: EM debt BENEFICIARY of dollar weakness; local-currency returns amplified by FX tailwind + rate cuts. However, spreads already compress (particularly IG), leaving limited upside and elevated refinancing risk if trade tensions escalate. Currency risk hedging increasingly expensive as USD weakness stabilizes.
indicator: Global Trade Dynamics & Tariff Impact
value: US tariff escalation (10% baseline + sector-specific 50% on India, China negotiations extended); EM tariff exposure heterogeneous (India, Brazil, Southeast Asia most affected)
source: State Street; Morgan Stanley; OECD Global Debt Report
implication: Tariff-driven growth headwinds for EM corporates and sovereigns; credit quality divergence emerging. India, Brazil face refinancing pressures on dollar-denominated debt; Mexico, Chile, Colombia less exposed. Trade-policy risk dominates currency-only narrative through 2026.
indicator: International Equity & Currency Flows
value: MSCI EAFE +22% YTD 2025 (10% attributable to USD weakness); foreign investor flows into US equities collapsed to $5.7B (Jan-Jul 2025) vs $10.2B in 2024; European-domiciled ETFs +$42B inflows YTD
source: J.P. Morgan Asset Management; Visual Capitalist
implication: Capital reallocation OUT of US equity exposure into non-US assets structurally pressuring dollar. This reflects valuation re-rating (US mega-cap tech expensive) not pure currency dynamics. Sustained only if US growth disappoints (consensus 1.4% in 2025, further deceleration risk 2026).
indicator: Gold Prices & Structural Demand
value: Gold +70% in 2025, surpassing $4,000/oz; J.P. Morgan forecasts $5,055/oz by Q4 2026, rising to $5,400 by end-2027
source: J.P. Morgan Global Research; Amundi; Brookings Institution
implication: Gold rally partly currency-driven (weak dollar), partly structural (CB reserve diversification, geopolitical hedging, inflation expectations). Commodity strength benefits commodity exporters (emerging markets) and pressures importers—mixed credit impact across EM universe.
indicator: US Treasury Yield Curve & Term Premium
value: 10-year yield ~4.5% (end 2025); curve steepening amid fiscal-concern repricing; long-duration premium elevated
source: Federal Reserve; Morgan Stanley; BlackRock
implication: Term premium expansion (not just Fed cuts) is credit-negative for corporates. Higher 10-year yields lift all IG/HY benchmark spreads and funding costs. EM sovereigns (USD-denominated) face higher base rates regardless of spread compression—real cost of capital rising.

Sources

February 16, 2026

Equity Research

(1 entry)
Bullish0-5 Year
Confidence: 7/10|Conviction: 6/10
The US dollar weakened sharply in 2025, driven by fiscal concerns and reduced confidence in policy. However, the structural case for sustained dollar weakness over the next 5 years is more nuanced than a simple bearish view. While the federal deficit totals $1.9 trillion in fiscal year 2026 and grows to $3.1 trillion in 2036, representing 5.8% of gross domestic product in 2026 and increasing to 6.7% in 2036, the dollar's structural position as the global reserve currency remains resilient. The US dollar's weakness in 2025 likely signals a turning point in its long cycle of strength—though not the end of its global dominance, with the greenback likely entering a more prolonged phase of cyclical weakness—not a secular decline. Central bank diversification into gold is real but measured: a record 43% of central banks indicated plans to increase their own gold holdings in 2025, up from 29% in 2024, with none anticipating a reduction, yet gold purchases are more consistent with most countries pursuing a modest diversification of international reserves that does not solely target a reduced dollar share, with gold reserve accumulation generally not associated with de-dollarization of international reserves at the country level, except in a few prominent cases. For equity investors, the 5-year implication is a cyclical—not secular—dollar weakness phase, which creates meaningful but not transformational tailwinds for international equities. The MSCI EM index has surged 22% year-to-date, outperforming the S&P 500 by 12%, marking the best start for EMs since 2017, with five key tailwinds including China's improving economic backdrop, resilience of many EM economies to tariffs, EM Asia's tech leadership, India's growth wave and a weaker US dollar. Tactical currency positioning and deliberate overweighting of non-US developed markets and selective emerging markets represent the most prudent equity response, rather than wholesale abandonment of US equities.

Key Data Points

indicator: US Federal Deficit (FY2026)
value: $1.9 trillion (5.8% of GDP)
source: Congressional Budget Office, February 2026
implication: Elevated deficits persist but are not unprecedented. CBO projects modest decline relative to prior trajectory, mitigating some degree of structural pressure on the dollar. However, debt-to-GDP rising to 120% by 2036 does create long-term headwinds for dollar strength.
indicator: US Dollar Index (DXY) 2025 Performance
value: Down ~9% since January 2025
source: Morningstar, December 2025
implication: Sharp depreciation reflects loss of carry advantage, policy uncertainty, and capital outflows. However, dollar remains elevated: among 34 major currencies tracked, only 9 are more overvalued than USD, suggesting limited further downside without structural catalyst.
indicator: Central Bank Gold Purchases 2025
value: ~950 tonnes (below 1,000t/year threshold); 43% of CBs plan to increase holdings
source: World Gold Council, January 2026
implication: Sustained diversification trend but slowing from exceptional pace. Not evidence of imminent dollar collapse; rather, gradual rebalancing. Federal Reserve analysis finds gold accumulation NOT strongly correlated with dollar reserve reduction except for geopolitically isolated countries.
indicator: USD Share of Global Foreign Exchange Reserves
value: 58% (down from ~63% in 2013)
source: JPMorgan Asset Management, 2025
implication: Gradual erosion over decade, but dollar dominance intact. Reserve share decline has occurred despite Fed rate hikes; driven more by structural valuation and geopolitical factors than policy rates.
indicator: MSCI EM Index 2025 YTD Return
value: ~30% (vs S&P 500 ~16%)
source: AllianceBernstein, November 2025; JPMorgan, December 2025
implication: Strongest EM performance in 15 years driven by currency tailwinds (~7-12pp of outperformance) plus fundamentals. Historically, 2002-2008 dollar bear cycle generated 29% CAGR EM returns. Current cycle early innings but not yet decade-long duration.
indicator: MSCI EAFE (Developed Non-US) Valuation vs S&P 500
value: EAFE near long-term average; S&P 500 at multidecade highs
source: Lazard Asset Management, December 2025
implication: Developed international equities offer superior risk-adjusted return potential, independent of currency movements. Shareholder yields near 20-year highs support relative attractiveness.
indicator: EM Equity P/E Ratio vs Earnings Growth (PEG)
value: EM: 12.9x 2025 earnings with 11.9% growth (PEG 1.1x) vs S&P 500: 23.1x earnings with lower growth (PEG 2.0x)
source: East Capital, December 2025
implication: Emerging markets offer substantially better value-to-growth profile. This advantage persists regardless of near-term currency movements, suggesting structural opportunity for 5-year investors.
indicator: JPMorgan Currency Forecast: EUR/USD
value: 1.19 by September 2025, rising to 1.22 by March 2026
source: JPMorgan Global Research, 2025
implication: Modest euro appreciation supports developed Europe and carries implications for EM FX. Forecast suggests depreciation path moderates after initial 2025 shock; not a persistent, accelerating trend.
indicator: Emerging Markets GDP Growth (2026-2030 IMF forecast)
value: 4.0% annually vs developed markets 1.7%
source: East Capital, December 2025; IMF World Economic Outlook
implication: Structural growth advantage for EM independent of currency. Over 5-year horizon, earnings growth differential should drive relative equity performance regardless of dollar trajectory.
indicator: Commodity Price Sensitivity to USD Weakness
value: Inverse correlation 0.7-0.8; dollar weakening of 10% typically supports commodity rally 8-12%
source: AllianceBernstein, May 2025; JP Morgan Commodities Research
implication: EM commodity exporters (Brazil, South Africa, Mexico) structurally benefit. Already pricing in 9% dollar weakness; further 5-10% depreciation would provide additional tailwind to EM fixed income and equity.
indicator: EM Hard Currency Debt Burden vs Developed Markets Debt/GDP
value: EM: 74% gross state debt/GDP vs Developed: 110% (2025 IMF data)
source: East Capital, December 2025
implication: EM fiscal position stronger than developed markets. Dollar weakness reduces EM debt-servicing burdens more than it helps developed nations. Positive for EM credit and equities.
indicator: Gold Price Target (5-year horizon)
value: $5,000-5,400/oz by end 2026-2027; structural support for further appreciation
source: JPMorgan Global Commodities Strategy, December 2025; VanEck, 2025
implication: Gold positioning reflects expected dollar weakness, diversification demand, and geopolitical risk premium. However, gold's 30%+ 2025 rally already prices in substantial weakness; further appreciation requires acceleration of debasement narrative.

Sources

February 16, 2026
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