Typically, a weaker US dollar helps developing countries by reducing their debt burden. However, the trade war that weakened the dollar also increased the risk premium on these nations, causing their actual borrowing costs to rise—an unusual and detrimental economic outcome.

A recent global fixed income sell-off was not triggered by a single U.S. event but by a cascade of disparate actions from central banks and data releases in smaller economies like Australia, New Zealand, and Japan. This decentralized shift is an unusual dynamic for markets, leading to dollar weakness.

Contrary to the historical norm where volatility rises with a strengthening dollar (risk-off), the market is now experiencing higher volatility as the dollar falls. This unusual 'dollar down, vol up' dynamic suggests a pro-cyclical market backdrop and has major ramifications for how FX options and risk reversals are priced.

The U.S. dollar's decline is forecast to persist into H1 2026, driven by more than just policy shifts. As U.S. interest rate advantages narrow relative to the rest of the world, hedging costs for foreign investors decrease. This provides a greater incentive for investors to hedge their currency exposure, leading to increased dollar selling.

Even if US inflation remains stubbornly high, the US dollar's potential to appreciate is capped by the Federal Reserve's asymmetric reaction function. The Fed is operating under a risk management framework where it is more inclined to ease on economic weakness than to react hawkishly to firm inflation, limiting terminal rate repricing.

A series of upcoming US policy events, including Fed appointments and defense spending debates, are collectively skewed towards dovish monetary policy implications and a weaker fiscal picture. This creates a coordinated downside risk profile for the US dollar, suggesting potential for weakness is greater than for strength.

In a regime of fiscal dominance, where government spending dictates policy, the currency, not bond yields, becomes the primary release valve for economic pressure. While equities and yields may appear stable, the true cost of stimulus will be reflected in a devaluing dollar, a risk often overlooked by bond vigilantes.

Key US policy risks, particularly the AIPA tariff ruling and the Lisa Cook confirmation hearing, present multiple channels for potential dollar downside but very few for upside. This creates an asymmetric risk profile where the dollar has significantly more room to fall than to rise from these specific events.

Officials at IMF meetings expressed surprise at how little the Trump administration has focused on foreign exchange rates. There is a growing expectation that this could change next year, with a renewed focus on the dollar if the US trade deficit fails to normalize, creating a latent political risk.