While global markets have experienced turbulence, the volatility has been particularly concentrated in U.S. assets, with instances of simultaneous selloffs in U.S. stocks, bonds, and the dollar—not something that happens often.
In our view, it appears that unprecedented policy uncertainty is shaking global investors’ confidence in U.S. markets. This has led to investors demanding a higher premium for holding U.S. assets and potentially reconsidering their substantial allocations.
This shift is dampening the dollar’s typical “safe haven” status.
The dollar’s status: why does this matter?
The United States imports than it exports, creating a gap called an external deficit. To fund that deficit, it requires significant inflows from foreign investors. Over the past decade, this has not posed a significant issue due to the attractiveness of U.S. markets. However, if this dynamic were to structurally change, it could lead to a weaker dollar and reduced U.S. asset outperformance. A similar scenario unfolded in the U.K. back in 2022 as it faced financial stability concerns.
Such a shift in portfolio holdings and currency allocations is unlikely to occur overnight. U.S. dominance has been the theme of the post-financial crisis era, with the U.S. weighting in the MSCI World reaching to its highest level on record. Additionally, foreign investors have been hedging a smaller portion of their currency exposure among those U.S. holdings.
Therefore, it is important to differentiate between the types of investors driving the dollar’s recent moves: 1) speculative traders that have been selling the dollar throughout this year, and 2) institutions and other ‘real money’ investors shifting their structural allocations.
Recent flow data indicates that while domestic investors have bought the dip in stocks, foreign investors have been selling U.S. equities at a record pace – surpassing even the levels seen during the COVID shock. This trend extends beyond stocks, as international investors, particularly in Europe, have broadly been selling U.S. assets in an atypical way. While, we don’t think the dollar’s status as the global reserve currency is at risk any time soon, a continuation of that asset rotation could turn the current cyclical downturn in the dollar into a more structural weakening.
For context, previous sustained periods of dollar weakness (1970-80, 1985-92, 2002-08) have typically resulted in a 40 percent depreciation over a 5-10 year period. While such a scenario is not on the horizon today, it is prudent to ensure portfolios are positioned accordingly in the event that it materializes.
How to think about currency diversification?
The U.S. economy and markets have outperformed for a number of years, leading to substantial U.S. and dollar weightings in investment portfolios. This accumulation has often occurred gradually, sometimes without investors being fully aware of the extent of their exposure.
2025 has highlighted the potential risks this can pose. For illustrative purposes, consider an investment made into a global portfolio with 60 percent equities and 40 percent bonds at the start of this year. For a euro-based investor that had not considered their currency exposure, that portfolio would be down more than -10 percent in local currency terms as of April 10. However, if they had hedged the investment back to euros, those losses would be cut in half to around -5 percent.
Given the current outlook, where risks to the dollar are now titled towards the downside, investors (particularly those who think of their wealth in another currency) may want to consider revisiting their currency allocations as part of an overall goals-based plan.
Alternative reserve currencies
From a pure diversification standpoint, central bank reserves can offer valuable insights. Like many investors, central banks have very long time horizons, with a primary objective to preserve purchasing power, and a priority for liquidity and safety while also seeking out some return. With nearly $13 trillion in assets under management, their bias is to have a higher allocation to currencies with deep, liquid financial markets that have a large universe of investable assets. Their largest non-U.S. dollar allocations are to gold and securities denominated in euros, Japanese yen and British pounds, along with a few others for diversification purposes like the Chinese renminbi, Swiss franc, Australian dollar or Canadian dollar.
To approach currency diversification, one might consider a larger weighting towards alternative reserve currencies with a lower correlation to global growth. To that end, the euro and Japanese yen are the most evident candidates poised to benefit from a rotation of U.S. portfolio holdings. For instance, as of November 2024, European investors, hold north of $4.5 trillion in U.S. corporate stocks.
Gold and yen considerations
Gold can continue to act as a good diversifier against dollar weakness as it has done historically. Given its nature as a physical store of value, gold has grown in popularity, particularly in times of geopolitical uncertainty. .
It’s important to note, that there is no perfect way to go about diversifying currency exposure. However, for illustrative purposes, from a starting point of a 100 percent dollar portfolio, one might consider gradually building towards a non-dollar exposure of 30 percent over time. That’s roughly in line with the non-U.S. exposure in the MSCI World.
The greatest portion of the 30 percent non-dollar exposure could be allocated to euro-denominated securities, where there are opportunities across both the equities and fixed income space. Beyond this, the next largest allocations could go towards gold as mentioned above (either in physical format or other) and the Japanese yen (considering select equity opportunities). The remaining holdings would be smaller in nature, but could provide some much-needed diversification with higher yields.
With the possibility of a softening trend for the U.S. dollar materializing on the horizon, it is reasonable to evaluate how heavily weighted portfolios are to the United States. While, we don’t think investors need to overhaul their U.S. asset allocations, recent market dynamics highlights the risks of over-reliance on a single market. In a changing environment, it’s essential to consider diversifying intentionally across regions and currencies to help strengthen portfolio resilience.
By Samuel Zief – global macro strategist and head of Global FX Strategy at J.P. Morgan Private Bank
