Dollar Demand Disrupted, Part 2 – Central Banks Diversify

Dollar dynamics – it’s not about rates

The table above demonstrates that the Fed’s policy rate remains elevated relative to peers, which should, in theory, support dollar demand. But that’s not what markets are showing, suggesting that the dollar’s slide isn’t about rates – at least not in the way textbooks would suggest.

The divergence is clearest in how EUR/USD trades. During New York hours, price action aligns closely with rate differentials and hasn’t moved much this year. But during London and Asia sessions, the dollar sees steady selling pressure. That suggests foreign investors aren’t responding to carry – they’re de-risking or hedging USD exposure. Whether due to geopolitical concerns, diversification, or reserve reallocation, capital is moving out of the dollar even as it offers one of the highest yields in the G10.

Where central banks stand

If the dollar is weakening even as U.S. rates stay elevated, it’s a sign that central banks elsewhere are setting the tone in other ways. This is where we see broader central bank policy moves –including balance sheet and reserve management – influencing global capital flows.

• Federal Reserve: wait and see. The Fed left rates unchanged last week, with guidance still pointing to two cuts this year. Growth forecasts in the Fed’s Summary of Economic Projections came down slightly, inflation nudged up. The Fed is still focused on rebalancing – not reacting – and while it isn’t rushing to ease, policy looks increasingly tight relative to peers. Reserve policy remains unchanged for now, but the Fed is planning to loosen commercial bank leverage rules in the near term.
• European Central Bank: leading the way down. The ECB cut rates by 25bps in April and signaled more to come. Its policy rate now sits at 2.25%. With euro area growth soft and inflation expectations anchored, the ECB sees more room to ease. Liquidity operations remain steady, but reserve balances have started to shift toward gold and non-dollar assets, mirroring broader reserve diversification trends.
• Bank of England: cautious cuts ahead. The BoE cut rates by 25bps in May, bringing the policy rate to 4.25%. It held steady in June, but the vote was close – three members backed another cut. Core inflation remains sticky around 3.5%, but the BoE sees progress and is signaling a slow, data-dependent path lower. Quantitative tightening continues, though some officials have raised concerns about its interaction with rate cuts. For now, the BoE is easing – just carefully.
• Bank of Japan: at the mercy of the markets. Japan is finally unwinding its ultra-loose stance. The BoJ ended negative rates in March and now plans to taper bond purchases, marking its first real step toward quantitative tightening. But the pace will be slow – impacted heavily by global policy uncertainty – and yield curve control remains in the background. Inflation remains inconsistent – again closely related to global dynamics, as currency volatility shapes import price inflation – and the BoJ is wary of tightening too quickly in a fragile economy.
• Bank of Canada: quietly easing. The BoC has brought its policy rate to 2.75%, with inflation back near target and growth soft. It’s ahead of the Fed in the easing cycle and likely to cut again if data cooperates. Reserve management has been uneventful, but the policy message is clear: the BoC is more focused on growth risks than lingering inflation.
• Swiss National Bank: small but symbolic. The SNB has cut its overnight rate to 0.25%, continuing a dovish pivot that began in early 2024. The move hasn’t derailed the franc, but it does reflect the SNB’s intent to stay ahead of disinflation. Reserve composition has shifted toward euro- and gold-denominated assets, with euros now making up about the same as U.S. dollars.

Central bank reserves management in a shifting world

In sum, central banks are not just easing – they’re repositioning. Reserve portfolios are adapting to a more fragmented and uncertain global order.

Gold continues to play a growing role. According to the World Gold Council, 95% of central bank officials (surveyed last month) expect global official gold holdings to rise over the next year. This trend is already visible in the data, with net purchases running well above historical averages.

Geopolitics is accelerating the shift, as well. In Europe, debate is heating up over gold held abroad – especially in the U.S. Germany and Italy have made calls to repatriate reserves from New York, spurred by rising global tensions and concerns about U.S. policy unpredictability under President Trump.

Portfolio strategy

As we mentioned last week, we believe it’s too early to say outright that U.S. assets are losing favor; the data simply don’t reflect it. In addition, moments of policy relief like the de-regulatory and tax-related news out of the U.S. this week, can contribute to brief disruptions in the dollar weakening trend. But diversification is happening – in central bank holdings even more than in investor portfolios.

Central banks have continued de-dollarizing and steady gold purchases are likely to keep the yellow metal supported in the medium term. Gold is up 28% year-to-date, and with central banks still buying, we think it makes sense for investors to stay aligned. As the saying goes, don’t fight the Fed – but the same holds true for other central banks.

Ex-U.S. bond markets have also had a strong 2025 so far. Global corporate bonds are among the top-performing fixed-income assets this year, supported by dollar weakness and easier monetary policy abroad. The renewed use of tariffs has added another tailwind, prompting greater interest in global diversification and reduced reliance on U.S. dollar assets.

In all, our expectation is that U.S. assets – and the connection to U.S. sources of growth, innovation, and return potential – are likely to remain dominant. But the depth and liquidity of U.S. capital markets mean that even changes on the margin can having meaningful impact to ex-U.S. valuations.