E-Paper
The bond market sell-off is helping the dollar
But the strength of the greenback is not as reliable as in the past
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NO FORECAST IS ever a complete consensus in financial markets. But some get close. At the end of 2025 the idea that the dollar would weaken was one of them. Dollar bulls were few and far between. Analysts from most big investment banks and asset-management firms made bearish predictions. So did The Economist: in February we suggested that the greenback might have much further to fall after a miserable run in 2025, as its safe-haven status continued to fade.
So far the dollar has defied such doubts. The DXY index, which measures the dollar against a small basket of rich-world currencies, has risen by 4% in 2026. It is at its highest level since Donald Trump first launched his trade world war in April last year. Several factors, not least global enthusiasm for American stocks, have helped frustrate the dollar doomsters. But these factors will not support the greenback forever.
The movements of other currencies are part of the explanation. Investors have soured on the euro, in particular. Europe’s single currency has weakened from $1.17 to around $1.12, owing to growing worries about political and fiscal stability in the currency union. The yield on French ten-year government bonds has risen from 3.5% to 4.8% this year amid fears of fiscal mayhem, and is now around 1.3-1.4 percentage points above the German equivalent. Investors dumping euros have only so many places to go: the dollar is one of the obvious ones (the euro is down against the British pound and Japanese yen this year, too).
Another reason for the dollar’s rally is darkly ironic: the rise in energy prices caused by America’s war with Iran. In the past high oil prices typically weakened the American currency. Oil was something that America bought from abroad, and although crude is priced in dollars, many of those it handed over to foreign sellers would eventually be converted into some other currency. Since America became a net energy exporter in the late 2010s, thanks to the shale-fracking boom, this mechanism has gone into reverse. Pricey petrol and diesel may be a political headache for Mr Trump’s Republican Party a month before midterm elections, but they are a salve for the greenback.
A deeper source of the dollar’s strength is the American economy, which continues to surprise even optimistic forecasters. Late last year economists expected annualised growth between 1.6% and 1.9% for each quarter this year. In reality, growth in the first and second quarters hit 2.5% and 2.2%, respectively, driven by strong household consumption and business investment related to artificial-intelligence infrastructure. Growth in the third quarter may have been even stronger, with Federal Reserve surveys suggesting 2.5%. Some indicators point to annualised expansion of over 3%.
A hot economy may force the Federal Reserve to keep raising interest rates, which makes owning Treasury bonds and other interest-bearing American assets more lucrative. In the 12 months to July foreign buyers bought a net $450bn or so of American corporate debt, the highest for any 12-month period in nearly two decades even after adjusting for inflation. Foreigners are even hungrier for American equities: in the same 12 months their net purchases of American stocks and investment-fund units amounted to some $900bn-worth. That is a record high for any 12-month stretch—and 80% above an earlier peak in 2021.
The problem for the dollar is that these sources of strength are narrower than in the past. Historically America’s currency rallied both when the country’s economy was going strong and when the world, even including America, was going to bits. This was the “dollar smile”, as Stephen Jen, a currency strategist and investor, dubbed it.
Now the smile is becoming more of a lopsided smirk. Although the dollar’s movement against the euro shows that its appeal as a safe haven is not gone, this is much less prominent than the allure of America’s risk assets. Should those assets disappoint—if the AI boom turns out to be a bubble and pops, for example—return-chasing investors will dump them, and the dollar, as quickly as they snapped them up. Currency traders had better get used to bigger mood swings.
