Dollar's bond-market buffer fades as 79% of central banks eye multipolar shift

The U.S. dollar's traditional bond-market buffer is eroding as a record share of central banks plan to reduce their dollar holdings, a structural shift that threatens to weaken the world's primary reserve currency over the long term.

Major dislocations in U.S. foreign policy are accelerating a dedollarization trend among central banks, with a net share of reserve managers now favoring a reduction in dollar holdings over an increase for the first time, according to a survey by the Official Monetary and Financial Institutions Forum.

"Reserve managers are gradually broadening their diversification strategies," the OMFIF survey found, with approximately 79% of central banks and 60% of public funds expecting the global monetary system to become increasingly multipolar. A net 30% of respondents plan to increase their gold holdings over the next one to two years, the survey showed.

The shift comes as the U.S. Dollar Index has gained 2.49% over the past month and 3.24% over the past six months, supported by expectations that the Federal Reserve may resume hiking rates. Markets now price a 50% probability of a rate increase to 3.75-4.0% at the September meeting, up from 22.5% a month earlier, according to the CME FedWatch tool. Deutsche Bank separately warned that the U.S. now relies more on foreign stock than debt flows, creating an additional vulnerability for the dollar.

A fading bond-market buffer could raise long-term U.S. Treasury yields and increase borrowing costs for the U.S. government, which finances a federal deficit that exceeded $1.8 trillion in the last fiscal year. If the dedollarization trend persists, it may trigger broader selloffs in dollar-denominated assets, affecting global forex, fixed-income, and equity markets.

The Bond Buffer That Protected the Dollar

For decades, foreign central banks' holdings of U.S. Treasuries acted as a structural support for the dollar, providing a captive buyer base that kept yields lower than they otherwise would have been. That buffer is now thinning. The OMFIF survey marks the first time since the forum began polling that a net-negative share of central banks expect to increase dollar reserves, with respondents citing rising political risks surrounding the currency.

The last time a comparable shift in reserve manager sentiment occurred was in the early 2000s, when the euro's launch prompted a gradual diversification away from the dollar. Over the subsequent five years, the dollar trade-weighted index declined roughly 20% as foreign central banks reduced their dollar allocation from about 71% to 64% of global reserves, according to IMF data.

Gold's Rising Role

Central banks are not merely reducing dollar exposure — they are actively rotating into alternatives. The net 30% of respondents planning to increase gold holdings over the next one to two years extends a buying spree that has seen central banks purchase more than 1,000 metric tons of gold annually in each of the past three years, according to the World Gold Council. This trend, if sustained, could gradually reduce reliance on the dollar and create long-term structural headwinds for the greenback.

At the same time, June's pullback in technology stocks highlighted growing concerns over AI valuations and the sustainability of the U.S. equity rally. As investors diversify toward economies with less concentration in technology, capital inflows into U.S. assets could moderate, reducing demand for the dollar.

Near-Term Support Remains

Despite the structural headwinds, the near-term outlook for the dollar remains constructive. Markets increasingly expect the Fed to keep monetary policy restrictive, with the probability of a rate hike at the October meeting rising to 46.7% from 30.8% a month earlier. Higher U.S. interest rates strengthen the dollar by increasing its yield advantage and boosting demand for FX carry trades.

The dollar's fate ultimately hinges on whether the Fed maintains its hawkish bias and whether the structural diversification trend accelerates. If central bank reserve managers follow through on their stated intentions, the dollar could face sustained pressure over the coming decade — even if it rallies through year-end.

This article is for informational purposes only and does not constitute investment advice.