Nominal Broad US Dollar Index
The DXY (U.S. Dollar Index) and the nominal broad US dollar index are both measures of the value of the dollar, but differ in composition and purpose. The DXY measures the dollar against a basket of six currencies (euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc), with the euro accounting for approximately 57% of the weighting, and is mainly used for trading and financial purposes. The Federal Reserve’s nominal broad dollar index, on the other hand, is much wider in composition and measures the dollar against currencies from a larger group of trading partners (more than 20 countries), with the weight of each currency determined by its share of US foreign trade, providing a more representative picture of the overall strength of the dollar in the global economy.
Productivity and exchange rates
To understand why the dollar may behave differently than expected, we must first look at an important economic principle. When a country experiences strong productivity growth, this affects the exchange rate. In general, more productive economies tend to have stronger currencies. This happens in two ways: either prices in the country rise, or the exchange rate goes up. Usually, it is a combination of both. The reality is, of course, somewhat more complicated. Interest rate differences between countries, government spending and investor confidence also play a role. Nevertheless, one rule usually remains true: a strong economy has a strong currency. This forms the basis for optimism about the dollar in the first months of 2026.
Euro/Dollar
January to December 2025
Three reasons for a strong dollar
The first reason for a strong dollar is the OBBBA programme. This programme provides extra support to the US economy and stimulates growth. When the government pumps more money into the economy, it usually helps its own currency. This is because economic activity increases and interest rates often rise. In addition, Jerome Powell will remain chairman of the Federal Reserve, the US central bank, until May next year. Inflation is still above the desired level. It is therefore doubtful that the Fed will lower interest rates anytime soon. The Fed wants to maintain its credibility and avoid the risk of recurring inflation. This cautious policy makes the dollar attractive to international investors.
The third reason is simple: the US economy is performing much better than those of Europe, the United Kingdom, Japan and Canada. Together, these countries represent 92% of the DXY index, the most important measure of the dollar’s value. Germany is struggling with an industrial recession, France has major budgetary problems, and Canada needs a weaker currency to boost lagging productivity.
Ten-year interest rates
The Japanese puzzle
The Japanese yen is an interesting part of the story. Prime Minister Takaichi’s government is preparing new public spending, which is pushing up interest rates on Japanese government bonds. Yet the yen has not strengthened; it has weakened. This raises questions.
During the first Abenomics period, an earlier economic stimulus programme, both the yen and bond yields fell as Japan tried to kick-start the economy. However, this pattern has changed since the coronavirus pandemic. Interest rates and the yen are no longer moving in the same direction.
The Japanese central bank faces a difficult choice. If the bank aggressively raises interest rates, the yen could suddenly strengthen. This would undermine the government’s stimulus programme and push Japan back into deflation. But if the central bank keeps interest rates low, inflation could rise, especially if the yen moves towards 160 against the dollar. Whichever path the Bank of Japan chooses, a further weakening of the yen seems unlikely.
The role of artificial intelligence
The strong productivity growth driven by artificial intelligence in the United States should be good for the pound sterling. When one sector of an economy becomes more productive, wages in that sector rise faster than elsewhere. The same principle applies to countries. If the US becomes more productive than other countries, one of two things will happen: incomes in America will rise faster, or the pound sterling will strengthen. Usually, we see both effects.
Of course, other factors influence the exchange rate, such as interest rate policy, public finances, and geopolitical risks. But if the AI revolution drives the US economy to grow faster than that of other developed countries, the dollar should strengthen.
Dollar futures positioning
Investor positioning in dollar futures tells a telling story. According to the weekly CFTC Commitment of Traders report, speculative investors (non-commercial traders) have now built up significant short positions in the dollar. This positioning reflects the broad sentiment that the dollar will weaken further. Historically, however, extreme positions in futures markets are often a contrary indicator. When too many investors are positioned in the same way, the potential for movement in that direction is largely exhausted. An unexpected positive development for the dollar could therefore lead to a sharp short squeeze, forcing investors to close their loss-making positions by buying dollars. This mechanism could actually strengthen the dollar at the very moment when the consensus is most negative, illustrating the paradoxical dynamics of currency markets.
July 2023 to December 2025
A changing relationship
A notable development is the shift in the relationship between the dollar index and US government bond yields. Traditionally, these two tended to move in the same direction. Since the beginning of this year, however, that link has been broken. This raises an important question: is the bond market signalling a stronger dollar, or is the dollar market anticipating a sharp decline in long-term interest rates? The answer to this question will be important for the second half of 2026.
The major shift in sentiment
The most striking difference from a year ago is the complete reversal in investor sentiment. At the beginning of 2025, there was still great euphoria about the US economy and a strong dollar. Now, at the end of 2025, almost everyone is expecting a weaker dollar. The dollar index has fallen by more than ten per cent this year. That is a big move for the currency market.
Many people now believe that the dollar will fall even further. They point to various factors: Trump’s trade tariffs, policy uncertainty, large US deficits, a weaker economy and a more accommodative policy from the Federal Reserve. These are all classic signs of a falling dollar. Of the ten factors that influence currencies, seven currently argue against the dollar: valuation, capital flows, political stability, economic performance, the current account deficit, the rising budget deficit, and momentum.
But there is another side to the story. Investor sentiment has already turned negative. The price trend has reversed. And many investors have already taken positions that profit from a falling dollar. European investors are positioned en masse for a weaker dollar. This means that many of the adverse developments have already been priced in.
Historically, this is precisely the moment when the opposite tests markets. When everyone leans in the same direction, the market tends to move in the opposite direction. Paradoxically, the current consensus on dollar weakness makes a stronger dollar more likely in the short term. The critical question now is: has the market priced in too much or too little of the negative factors?
No alternative in sight
Despite all the talk about the end of dollar hegemony, the reality remains stubborn: there is simply no alternative. More than 80% of all currency transactions are conducted in dollars, and nearly 60% of global reserves are held in dollars. These are network effects, similar to how Microsoft Windows remained dominant – not because it was the best operating system, but because everyone used it.
The euro suffers from fundamental design flaws. You cannot build a fully-fledged capital market on twenty-seven different legal systems with twenty-seven regulators. Every crisis – from Greece to the energy crisis – exposes the weakness of a monetary union without real fiscal and political integration. European companies still find it easier to obtain financing in the United States than in their own region.
Conclusion
The dollar is likely to remain stable or even strengthen in the first half of 2026. The US economy is outperforming other countries, the Federal Reserve remains cautious about cutting interest rates, and other major currencies are weak. Some weakening may occur in the second half of the year. This could happen if other economies benefit more from AI-driven productivity gains and if US fiscal support declines, which is by no means a foregone conclusion.
The image of a collapsing dollar is premature. It takes too little account of the fundamental strength of the US economy and the absence of a real alternative. The gradual fragmentation of the monetary system is irreversible, but it will take decades. No currency enjoys eternal dominance – the British pound reigned until the First World War, after which the dollar took over. Perhaps the dollar is on the eve of a similar transition, but that is a long-term process.
