The Dollar at a Crossroads: From Fed Cuts to Global Currency Shifts

A. With the Fed rate cut, will it lead to the start of weakening of the US dollar

A Fed rate cut usually weakens the dollar because:

1.     Lower yields: When the Fed cuts rates, U.S. Treasury yields fall. That makes dollar-denominated assets less attractive compared to other currencies, reducing demand for the dollar.

2.     Capital flows: Investors often shift money into higher-yielding emerging markets when U.S. rates drop, which can pressure the dollar.

3.     Inflation expectations: If markets think easier policy will stoke inflation, the dollar can lose purchasing power over time.

4.     Interestingly in the recent Fed just cut rates, the dollar actually strengthened immediately after the cut, because Powell framed it as a “risk management” move rather than the start of an aggressive easing cycle.

Dollar outlook scenarios after a Fed rate cut over the next 6–12 months.

B. Will weakening of the USD lead to the fall of US dollar hegemony

Why the dollar is still dominant

1.     Reserve currency status: Around 60% of global FX reserves are still held in dollars.

2.     Trade invoicing: Roughly 80% of global trade is invoiced in USD, even when the U.S. isn’t directly involved.

3.     Safe-haven role: U.S. Treasuries remain the deepest, most liquid market in the world, making the dollar the default refuge in crises.

4.     Financial plumbing: Global payment systems (like SWIFT and dollar-clearing banks) are dollar-centric, reinforcing network effects.

J.P. Morgan research points out that de-dollarization is real but gradual: the USD share of central bank reserves has fallen to a two-decade low, and more commodities are being priced in non-dollar contracts.

The possible paths of USD

1.     Short-term weakening, no hegemony loss: Most likely. The dollar can weaken 5–10% in cycles without altering its global dominance.

2.     Gradual erosion: If more trade shifts to yuan, euro, or regional currencies, and central banks diversify reserves, the dollar’s share could decline slowly over decades.

3.     Sharp loss of dominance: Unlikely in the near term, but possible if U.S. fiscal deficits spiral, political instability deepens, or rivals (like BRICS) successfully build alternative financial systems.

C. Timeline of risks on dollar dominance

1.     Near term (1–5 years): Weakening dollar ≠ end of hegemony

·       Cyclical weakness only: Dollar may soften due to Fed rate cuts and capital flows into emerging markets.

·       Weaponization backlash: Sanctions and reserve freezes (e.g., Russia’s $300B in 2022) have already pushed countries like China, Russia, and BRICS to explore alternatives.

·       Reserve diversification: Central banks slowly reduce USD share (already at a two-decade low), shifting marginally into gold, yuan, and euro.

·       Impact: Dollar remains dominant, but cracks in confidence widen.

2.     Medium term (5–10 years): Gradual erosion as de-dollarization accelerates in trade and reserves

·       Commodity pricing shifts: More oil, gas, and metals contracts priced in yuan, rupees, or regional currencies.

·       Regional blocs: BRICS+ or Latin America may experiment with shared settlement currencies.

·       Treasury demand: Foreign ownership of U.S. Treasuries continues to decline, raising U.S. borrowing costs.

·       Impact: Dollar share of reserves could fall from ~60% to ~50%. Still dominant, but less overwhelming.

3.     Long term (10–20 years): Possible shift to a multipolar currency system, with the dollar still central but less dominant

·       Parallel systems: Alternative payment networks (e.g., China’s CIPS) gain traction alongside SWIFT.

·       Fiscal strain: If U.S. debt/GDP keeps rising unchecked, confidence in Treasuries as the “risk-free” asset erodes.

·       Multipolar reserve world: Dollar, euro, yuan, and possibly digital currencies share global reserve status.

·       Impact: Dollar hegemony transitions into dollar primacy but not monopoly—still first among equals, but no longer unchallenged.

D. What this means for investors

1.     Currency Diversification

·       Don’t assume the dollar will always dominate.

·       Hold a basket of currencies (USD, EUR, JPY, CNY, CHF, GBP) to reduce concentration risk.

·       Consider currency-hedged ETFs or multi-currency bond funds.

2.     Reserve Asset Shifts

·       Central banks are already diversifying into gold and non-dollar assets.

·       Investors can mirror this by holding precious metals and commodities as hedges against dollar erosion.

3.     Geopolitical Risk Premium

·       Multipolarity means geopolitics matters more than in the U.S.-led unipolar era.

·       Investors should track regional blocs (BRICS, EU, ASEAN) and their currency policies.

·       Political shocks may cause sharper FX swings than before.

4.     Trade & Supply Chain Realignment

·       More trade invoiced in yuan, rupees, or euros means corporates’ currency exposures shift.

·       Investors should check whether companies they own hedge effectively against multi-currency risks.

5.     Liquidity & Safe-Haven Dynamics

·       The U.S. Treasury market remains the deepest, but liquidity could fragment.

·       Investors may need to balance Treasuries with Bunds, gilts, or even supranational bonds.

·       Safe-haven flows may split across USD, CHF, JPY, and gold.

6.     Digital & CBDC Evolution

·       Central Bank Digital Currencies (CBDCs) could accelerate multipolarity.

·       Investors should watch adoption of e-CNY or digital euro as settlement tools.

·       This may create new FX volatility but also new investment vehicles.

E. With the fall of USD Hegemony, which currency would most likely replace USD

1.     Euro (EUR)

·       Strengths:

Second‑largest reserve currency (~20% of global reserves).

Deep, liquid bond markets in the eurozone.

Widely used in trade, especially across Europe, Africa, and parts of the Middle East.

·       Weaknesses:

Fragmented fiscal union (no single Eurobond market like U.S. Treasuries).

Political risks (Brexit‑style shocks, populism).

2.     2. Chinese Yuan (Renminbi, CNY/RMB)

·       Strengths:

China is the world’s largest trading nation.

Yuan is already included in the IMF’s Special Drawing Rights (SDR) basket.

Growing use in commodity trade (oil, gas, metals) and Belt & Road projects.

Digital yuan (e‑CNY) could accelerate cross‑border adoption.

·       Weaknesses:

Capital controls limit free convertibility.

Shallow bond market compared to U.S. Treasuries.

Trust deficit: global investors wary of political/legal risks.

3.     3. IMF Special Drawing Rights (SDR) or a “basket” system

·       Strengths:

Neutral, supranational unit backed by multiple currencies (USD, EUR, CNY, JPY, GBP).

Reduces reliance on any single country’s policies.

·       Weaknesses:

Not a true currency—more of an accounting unit.

Limited liquidity and infrastructure for global trade invoicing.

4.     4. Gold & Digital Assets (wild cards)

·       Gold: Central banks are already buying record amounts as a hedge against dollar risk.

·       Digital currencies: CBDCs (like e‑CNY, digital euro) or even stablecoins could play a role in settlement, but they lack the scale and trust to replace the dollar soon.

F.  A head‑to‑head comparison of the euro vs. the yuan (renminbi) as challengers to U.S. dollar dominance:

1.       Strengths & Weaknesses

Euro

·       Strengths: Convertibility, institutional trust, large reserve share, deep markets.

·       Weaknesses: Fragmented fiscal union, political risks (Brexit‑style shocks, populism).

Yuan

·       Strengths: Trade heft, Belt & Road expansion, digital yuan innovation, rising share in global payments.

·       Weaknesses: Capital controls, lack of transparency, limited safe‑haven appeal.

2.       Likely Outcome

• Euro: Best positioned as the incremental alternative to the dollar in reserves and trade invoicing.
• Yuan: Best positioned as the long‑term challenger, especially if China liberalizes capital flows and global adoption of the digital yuan accelerates.
• Reality: Neither is ready to replace the dollar outright. The more likely future is a multipolar system: USD still central, but EUR and CNY steadily gaining share.

3.  Bottom Line

• Euro = credibility and convertibility today.
• Yuan = growth potential tomorrow.
  Together, they represent the twin pillars of a post‑dollar‑dominant world, but the transition will be gradual, not sudden.