QNB highlights structural challenges facing US dollar

QNB reported that the US dollar has maintained its status as one of the world's most important currencies and strongest financial assets over the past fifteen years, gaining more than 50 percent in value from the time of the global financial crisis and the European debt crisis (2008-2011) up to the second inauguration of Donald Trump as US president in 2025.

In its weekly report, the bank said that the dollar's sustained rise was driven by the enduring outperformance of US financial markets and the reliance of global investors on dollar-denominated assets as a safe haven.

 Weak liquidity and heightened risk in both advanced and emerging economies drew capital flows into US Treasury bonds and equities, which benefitted from deep markets and unique advantages in security and innovation.

However, QNB noted that the factors supporting the dollar's strength have come under significant pressure in 2025. 

The US Dollar Index (DXY) has fallen more than 10 percent since the start of the year, its largest annual drop since 1973, when President Richard Nixon ended the dollar's link to gold. 

The decline has been broad-based, spanning all major currencies in the index basket, including the euro, yen, British pound, Canadian dollar, Swedish krona, and Swiss franc.

Trade-weighted, inflation-adjusted exchange rate measures continue to show the dollar as overvalued relative to historical norms, particularly over the long term, reflecting changes in trade patterns, economic imbalances, and inflation differentials.

The report projected a marked decline in US exceptionalism, with growth and interest-rate differentials narrowing toward those of other advanced economies. 

QNB expects the gap in GDP growth between the United States and the euro area, which averaged 220 basis points in favor of the US in recent years, to shrink to about 70 basis points during 2025-2027. 

This shift is likely to be driven by US fiscal and immigration policies alongside more positive fiscal dynamics in the eurozone. 

The European Central Bank is expected to complete, or nearly complete, its monetary easing cycle, while the US Federal Reserve is forecast to implement significant interest-rate cuts through the remainder of 2025 and into 2026.

As a result, the real interest-rate spread between the US and the eurozone is projected to narrow from the current 170 basis points to zero by late 2026, which would favor a stronger euro and push the US Dollar Index lower. Because the euro makes up 57.6 percent of the DXY basket, even moderate euro appreciation could have a notable impact.

The report also highlighted US efforts to restructure its economy by reducing the current-account deficit and encouraging the reshoring of strategic industries. These moves could cut trade surpluses among key partners and reduce capital flows that traditionally support the dollar. Adding to the pressure is the United States' negative Net International Investment Position (NIIP), estimated at about $24.6 trillion, which implies a gradual adjustment that could weigh on the currency.

Despite these headwinds, QNB concluded that the current indicators do not point to an excessive or disorderly decline in the dollar in 2025. While the first half of the year has seen a sharp drop, continued selling pressure is more consistent with a gradual correction driven by elevated valuations and cyclical and structural economic factors rather than a collapse in confidence.