Capital Glut Meets Currency Strain: The Dollar's Slide Isnt Over

The US dollar has entered a period of sustained depreciation, and while currency markets are notoriously volatile, the forces driving this move are structural, not sentimental. At the core is a growing mismatch: the supply of US financial assets—primarily government debt but also corporate issuance—is surging, while global demand is not keeping pace. As this imbalance widens, the dollar must fall to clear the market.

This isn’t about cyclical weakness or political uncertainty. It’s about fundamentals. The United States is producing more dollar-denominated assets than the rest of the world is willing or able to absorb at current valuations. Without a significant repricing—through higher yields or a weaker currency—the system becomes unsustainable.

US Asset Supply Is Flooding Global Markets

The US federal government is running deficits at a scale that far exceeds historical norms outside of wartime or major crises. For fiscal year 2024, the deficit surpassed $1.9 trillion, and Treasury projections indicate continued heavy issuance, likely exceeding $2 trillion annually for the foreseeable future. The Biden administration’s spending commitments, combined with rising entitlement costs and higher interest payments, are not being offset by tax increases or budget cuts.

But government borrowing is only part of the story. The private sector is also tapping markets at record pace. US corporations are issuing bonds to refinance debt accumulated during the low-rate era, and equity markets are seeing high volumes of initial public offerings, private equity exits, and follow-on offerings. In short, dollar-denominated financial instruments are in abundant—and growing—supply.

Global Demand Is Receding

Historically, the US could rely on the rest of the world to absorb this capital. Foreign central banks, sovereign wealth funds, and institutional investors treated US Treasuries as a reserve necessity and US equities as a growth engine. That dynamic is breaking down.

China and Japan, the two largest foreign holders of Treasuries, have significantly reduced their positions. The People’s Bank of China has been diversifying into gold and non-dollar assets, while Japan’s Ministry of Finance is under pressure to support the yen amid persistent depreciation. Across emerging markets, central banks are rethinking reserve allocation strategies in light of dollar volatility and geopolitical risks.

Private investors are also showing restraint. The cost of hedging dollar exposure has risen markedly, particularly for euro- and yen-based investors, reducing the relative attractiveness of US bonds. Add to that concerns over fiscal policy gridlock in Washington, and the appetite for US assets begins to wane.

Recent data from the US Treasury’s TIC (Treasury International Capital) system confirms this trend. Net foreign purchases of long-term US securities have slowed considerably. The marginal foreign buyer is no longer absorbing the flow.

The Dollar as the Adjustment Valve

In a freely traded financial system, some component must adjust to resolve supply-demand mismatches. When yields can’t rise fast enough to attract capital—either because it would threaten economic growth or financial stability—the currency takes the strain.

This is where the dollar comes in. As global demand weakens, a falling dollar makes US assets cheaper in foreign currency terms, gradually restoring relative attractiveness. This process is already underway, with the dollar index (DXY) down nearly 8% from its 2023 peak.

Valuation models from the IMF and the Bank for International Settlements show the dollar remains overvalued by 10–15% on a trade-weighted basis. In this context, further depreciation is not only likely—it’s necessary.

A weaker dollar boosts export competitiveness and can reduce the trade deficit, but it also raises import costs, adding pressure to inflation. For the Federal Reserve, this presents a policy dilemma: tolerate a cheaper dollar to ease capital rebalancing, or raise rates further to defend the currency and attract inflows—potentially at the cost of growth.

Strategic Repercussions for Investors and Policymakers

As the dollar weakens, global asset allocators are rebalancing. Sovereign funds and pension managers are increasing exposure to non-dollar assets, from eurozone sovereigns to emerging market debt and commodities. Gold, long a hedge against dollar debasement, has surged in recent quarters.

This realignment may persist for years. The euro and the yuan, despite their own limitations, are gaining in relative share of reserves. Even digital currencies and central bank digital currency (CBDC) frameworks are being explored as alternatives to dollar-denominated reserves.

Trade policy may also be affected. A weaker dollar narrows the US current account deficit in the short term but can provoke competitive devaluations elsewhere. Already, Japan and South Korea have voiced concern over currency moves, and interventions in FX markets are becoming more frequent.

Conclusion: A Necessary Adjustment, Not a Temporary Dip

The US dollar’s decline is a rational market response to an imbalance that cannot be resolved by yields alone. The world simply cannot absorb the volume of US assets being produced without a pricing reset—and the dollar is the most flexible tool available.

This is not a crisis. It is a correction. But unless US fiscal dynamics improve or global capital demand unexpectedly rebounds, the dollar is likely to continue falling. For investors and policymakers, the implications are broad: capital flows, inflation, and geopolitical leverage are all tied to the fate of the dollar. The adjustment may be messy, but it is overdue.

Author: Ricardo Goulart