The most pressing priority for euro-based investors in the coming months? Mitigating dollar risk within their portfolios. This is a foundational principle for constructing portfolios in the current market environment, though with a key caveat: diversification is paramount.
While a prolonged downturn for the US dollar is not a certainty, the conditions are increasingly favorable for a multi-year bear market, according to investment strategists. The dollar’s dominance has waned since 1971, with its share of global foreign exchange reserves falling from a peak of 73% in 2001 to 58% currently. This historical pattern of cycles suggests a shift is underway, even as the dollar remains the world’s primary reserve currency.
The weakening dollar presents both challenges and opportunities. For euro-based investors holding US-denominated assets, a declining dollar could erode returns. However, history suggests this isn’t necessarily the case. Examining past periods of significant dollar weakness – the Plaza Accord of 1985-1987, 2003-2007, and 2017 – reveals that equity markets often compensate for currency depreciation, particularly when companies have substantial global exposure. Many S&P 500 companies generate roughly 40% of their revenues outside the US, creating a natural hedge against currency fluctuations.
Navigating the AI Landscape
Regarding US technology, the primary concern isn’t necessarily a bubble, but rather the “circularity of investments.” The interconnectedness of companies within the artificial intelligence ecosystem creates a systemic risk – a disruption in one area could trigger a domino effect. Despite this, a complete exclusion of US technology isn’t advisable.
Investment is currently at unprecedented levels, though profitability, margins, and debt remain relatively low. This suggests a super cycle is in its early stages. However, given the dollar’s weakness, mitigating risk through alternatives outside of the Nasdaq is prudent. Asia, particularly China, is emerging as a key driver of the AI ecosystem, with increasing liquidity.
Equities: Opportunities in Emerging Markets
a model portfolio should allocate the largest weighting – relative to index size – to emerging markets, encompassing both equities and local-currency bonds. These assets stand to benefit from a weaker dollar. Within the equity portion, emphasis should be placed on mid- and small-cap companies, particularly in Europe, to diversify risk and offset dollar exposure. A portion of the portfolio should also be allocated to undervalued European companies, focusing on the “value factor.”
Bonds: Shifting Away from Government Debt
On the fixed income side, strategists are focusing on credit – both investment grade and high yield – but exclusively in euros to neutralize currency effects. This approach acknowledges the potential for a broader shift away from the dollar, or even a new monetary order, which could lead to further dollar weakness.
There’s a current dilemma regarding whether the world is experiencing dedollarization or a new monetary order. In either scenario, the risks of a weakening US currency are elevated, and the dollar’s historical indispensability is increasingly uncertain.
Despite these concerns, there’s limited interest in euro-denominated government bonds. The preference is for the corporate segment, capitalizing on the “carry” – the return generated by holding bonds to maturity without selling them.
Several currencies are being highlighted as potential beneficiaries of dollar diversification. The euro, as the most liquid alternative to the US dollar, is expected to gain as investors move away from dollar-denominated assets. This trend could be further supported by the Federal Reserve resuming rate cuts while the European Central Bank concludes its easing cycle, alongside ongoing negotiations to resolve the Russia-Ukraine war. The EUR/USD exchange rate could reach 1.23 by September 2026, depending on the performance of the US economy.
The Norwegian krone is also attracting attention, as it’s highly sensitive to European economic growth, potentially benefiting from increased fiscal spending in Germany and joint European defense initiatives. The Norges Bank has signaled caution regarding further rate cuts, suggesting potential support for the krone. EUR/NOK is forecast to reach 11.00 by next September.
Finally, the Australian dollar is poised to benefit from rising real household incomes, increasing house prices, and easing US-China trade tensions. While the Reserve Bank of Australia is expected to cut rates, the pace will likely be slower than the Federal Reserve’s. Continued government stimulus could also boost economic data, potentially driving AUD/USD towards 0.70 in the first half of 2026.
a strategic review of currency allocations and consideration of hedging US dollar exposure embedded within US assets is crucial for euro-based investors navigating the evolving global economic landscape.
