During the first quarter of the year, the dollar showed a sideways/downward trend with volatility, especially in March. According to experts, we are witnessing a transition from a strong dollar—as seen between 2022 and 2024—toward a more neutral, and even weak, environment. In this regard, the first three months have resulted in a slight depreciation of the dollar and an open debate about its role as a global benchmark and its fundamentals.
“The obituary of the U.S. dollar has been written many times, with increasing frequency over the past year, but most of the catastrophic analyses of the currency focus on only one side of the equation and overlook the full picture,” laments Sonal Desai, CIO of Fixed Income at Franklin Templeton.
The Failed ‘Petrodollar’ Thesis
As a result of this connection, the “petrodollar” thesis has gained traction, arguing that the dollar’s dominance is sustained by oil trade being denominated in U.S. dollars, and that the shift of crude exports from the Middle East to Asia, along with the localization of Gulf defense spending, signals the beginning of the end of dollar hegemony. In Desai’s view, this perspective is notably simplistic: “It partially reverses the causal relationship. Oil-exporting countries have a strong self-interest in receiving payments in dollars because of what dollars represent: access to the deepest and most liquid capital markets in the world, supported by an institutional and legal framework that protects property rights and enforces contracts, and backed by a strong, dynamic, and innovative economy.”
According to the Franklin Templeton expert’s analysis, three pillars sustain this system: the scale and dynamism of the U.S. economy, institutional credibility, and unmatched market depth. “There is also no credible alternative; the euro lacks a unified large-scale safe asset; the renminbi operates under capital controls; and digital currencies may settle transactions but do not provide the store-of-value function required of a reserve currency,” Desai adds.
An Open Debate
She also argues that the data supports this view in areas such as reserves, payments, foreign exchange trading volumes, and the depth of the Treasury market—metrics not typical of a currency in decline. “Dollar weakness is cyclical, not structural, although its true vulnerability lies in U.S. fiscal policy. For investors, I maintain a constructive view on the dollar’s status as a reserve currency in the foreseeable future and would recommend staying agile at the margins and focusing on fundamentals. I believe investors should look at bilateral exchange rate movements rather than betting on the end of the dollar dominance regime,” she concludes.
However, Thomas Hempell, Head of Macro & Market Research at Generali AM (part of Generali Investments), is more critical and emphasizes that, in the short term, the evolution of the U.S. dollar remains closely tied to how the conflict in the Middle East unfolds. “It is not so much that the dollar has regained its role as a safe haven, but rather the effect of oil prices: when oil rises, the dollar now tends to benefit, as the United States has become a net energy exporter. By contrast, the euro and the yen are affected, as Europe and Japan import much of their energy, so rising oil prices worsen their trade balances and growth outlook,” he argues.
Outlook for the Dollar
Looking ahead, Hempell expects the dollar to weaken again if the war subsides soon and oil prices decline. He argues that global investors are likely to continue diversifying their portfolios away from the dollar, and that a conflict with Iran could even erode the system’s reliance on the petrodollar. “This maintains the medium-term upward trend of the euro/dollar pair, although to a lesser extent than we would have expected before the war, as energy prices are likely to remain structurally higher and the eurozone recovery will now be more moderate,” he explains.
Economists at BofA are also bearish on euro/dollar in the short term: “Our forecast for the end of the second quarter is 1.14, with downside risks.” Their thesis is that persistently high energy prices generate stagflationary pressures globally and a slower convergence of growth between the U.S. and the eurozone. In addition, the divergence between the Fed and the ECB that BofA economists expect later this year creates an interesting backdrop: on one hand, an ECB focused on preserving its inflation credibility versus a Fed prioritizing the labor market could support euro/dollar; on the other hand, they acknowledge that the outlook becomes more complex when analyzing forecasts in real terms.
“Beyond short-term factors, the dollar still faces potential downside risks from the U.S. labor market, private credit, and rising fiscal risks. In the longer term, the implications of the shifting geopolitical environment will continue to raise questions about optimal exposure to the dollar. We forecast euro/dollar at 1.20 by year-end, contingent on the Fed not raising rates, energy normalization, and gradual growth convergence between the U.S. and the eurozone,” they conclude.
