Global Currency Markets React to U.S. Dollar Decline and Geopolitical Tensions

U.S. Dollar Hits Three-Year Low Amid Fed Independence Concerns

The U.S. dollar has fallen to its lowest level in over three years, driven by investor concerns over the Federal Reserve’s independence following renewed political interference. President Donald Trump intensified pressure on the Fed by criticizing current Chair Jerome Powell and suggesting alternative candidates who may align more closely with his economic agenda, raising fears of politically motivated monetary policy and potential interest rate cuts. These actions, together with Fed official Michelle Bowman’s recent dovish comments, have increased market expectations for a rate cut in July. As a result, the dollar has declined 10% this year, on track for its worst performance since 2003. Global confidence in the dollar is further undermined as central banks, notably in Europe, reassess their reliance on the U.S. currency amid doubts about U.S. institutional stability. A survey by OMFIF revealed that 70% of central bank reserve managers are now discouraged from investing in the dollar due to U.S. political uncertainty. Analysts warn that any appointment of a Fed chair perceived as politically biased could further destabilize markets and erode the dollar’s traditional safe-haven status, especially in a volatile geopolitical climate.

Hong Kong Intervenes to Defend Currency Peg

On June 26, 2025, the Hong Kong Monetary Authority (HKMA) intervened in the foreign exchange market, spending HK$9.4 billion (US$1.2 billion) to support the Hong Kong dollar as it approached the lower limit of its trading band at HK$7.85 per US dollar. This move, aimed at maintaining the currency peg, will reduce liquidity in the banking system and has already pushed the overnight interbank lending rate to 0.0375%, its highest since mid-May. The intervention has the potential to disrupt one of the world’s most lucrative carry trades, where investors borrow in low-yielding Hong Kong dollars to invest in higher-yielding US assets.

Central Banks Diversify Reserves Amid Dollar Decline

A recent report by the Official Monetary and Financial Institutions Forum (OMFIF) reveals that global central banks, managing a combined $5 trillion in reserves, are increasingly diversifying away from the U.S. dollar following recent geopolitical and market upheavals, including policies introduced by U.S. President Donald Trump. The shift is boosting interest in gold, the euro, and China’s yuan. A net 40% of central banks plan to increase gold holdings over the next decade, the highest level in five years. The dollar, once the most favored currency, dropped to seventh place in popularity, with 70% of respondents citing the U.S. political environment as a deterrent. The euro is now the most in-demand currency for near-term reserve increases, with a net 16% of banks planning to raise euro holdings, followed closely by the yuan. Over the next decade, the yuan’s share of global reserves could triple to 6%. Analysts believe the euro could regain a 25% share of global reserves, recovering ground lost during the eurozone crisis, especially if the EU strengthens its bond market and capital integration. Despite the diversification, the dollar is still expected to maintain a dominant 52% share of reserves by 2035, down from 58% today.

China Faces Currency Policy Dilemma

China is grappling with a currency trilemma—whether to allow the renminbi (RMB) to appreciate, depreciate, or maintain stability. Despite downside risks associated with appreciation in a sluggish domestic economy, the author argues that a long-term strategy favoring a stronger RMB is essential. A stronger RMB aligns with China’s goals of global currency influence and fostering a multipolar currency system. Stabilizing the exchange rate in the face of US dollar volatility has weakened the RMB against regional currencies, heightening economic imbalances. Depreciation, though potentially boosting exports, risks trade tensions and competitive devaluations. Instead, appreciation could curb China’s trade surplus, reduce savings, and encourage consumption. With the RMB currently undervalued, structural shifts in domestic policy—boosting consumption and reducing unproductive investment—are needed. A stronger RMB supports China’s ambitions in green technology, AI investment, and greater international use of its currency. It would also help enhance RMB use in global finance and bolster China’s role in a more balanced global financial system. The currency’s increasing role in trade, financing, and digital payment systems like CIPS and mBridge underscores this potential. Beijing’s currency policy could thus shape the future of global monetary systems amid changes in dollar dominance.

Asian Currencies React to Middle East Conflict

Investor sentiment towards Asian currencies has weakened due to the ongoing conflict between Israel and Iran, which elevated oil prices and bolstered demand for the U.S. dollar as a safe haven. According to a Reuters poll of 11 respondents, bullish positions in the South Korean won, Taiwan dollar, Indonesian rupiah, and Malaysian ringgit have slightly declined. Rising oil prices are particularly problematic for oil-importing Asian economies, exacerbating current account deficits.

The poll also showed a shift to bearish positions on the Philippine peso for the first time since March, due to its vulnerability to oil shocks and successive interest rate cuts by the central bank to support growth. Additionally, sentiment toward the Indian rupee deteriorated following a substantial rate cut by the central bank and expectations of dividend repatriation pressures.

Political uncertainty has weakened support for the Thai baht as Prime Minister Paetongtarn Shinawatra faces criticism over a border dispute with Cambodia, leading to coalition instability. Meanwhile, the Bank of Thailand left interest rates unchanged.

The poll captures investor positioning in nine Asian currencies and highlights shifting market dynamics in response to geopolitical tensions and differing monetary policies.

Conclusion

The global currency markets are experiencing significant volatility due to a combination of political interventions, central bank policies, and geopolitical tensions. The U.S. dollar’s decline has prompted central banks to diversify their reserves, while regional conflicts and economic policies are influencing currency valuations worldwide. Investors and policymakers must navigate these complex dynamics to maintain economic stability and growth.