Is The Dollar's Global Reserve Role At Risk After Moody's Downgrade?

As Moody's strips the U.S. of its last AAA credit rating, financial markets and currency analysts are weighing whether the dollar's role as the world's primary reserve currency could slowly erode.

Analysts across major institutions agree that Treasuries remain indispensable in global finance, and no mechanical turmoil is expected in the near term.

Yet, the downgrade's timing and symbolism—arriving amid growing fiscal deficits, political uncertainty and weakening sentiment—have amplified calls for greater diversification from dollar-denominated investments for foreign investors.

Dollar’s Dominance Isn't Over, But It's Under Pressure

"The link between U.S. sovereign risk, Treasuries, and the dollar is one of capital flight," said Chris Turner, analyst at ING Group.

"Are global investors shifting their portfolios away from the U.S.?"

He highlighted that March data from the U.S. Treasury's International Capital report showed foreign buyers added $26 billion in Treasuries, though China trimmed its holdings by $19 billion.

Turner said upcoming TIC data for April, due mid-June, will be key to determining any real trend.

Downgrade Could Spark Market Volatility

According to Alejandro Cuadrado, forex strategist at BBVA, Moody's downgrade—though symbolic—arrives at a vulnerable time.

"It may act as a psychological catalyst," he said. Unlike S&P's 2011 or Fitch's 2023 downgrades, this one coincides with bearish sentiment in Treasuries and rising global fiscal concern.

Cuadrado said the structural use of Treasuries in collateral systems, reserve portfolios and liquidity management remains unchanged.

Still, "in this macro environment, the downgrade could amplify market jitters and FX volatility," he said, potentially weakening the dollar's ability to rebound after a three-month slide.

"The downgrade highlights long-term risks, including debt sustainability, which could further erode the dollar's haven appeal," George Vessey, lead macro strategist at Convera, said.

Time to Start Reducing Dollar Exposure?

According to UBS, the recent consolidation in the dollar following earlier weakness offers a strategic moment for reallocation.

"We believe that this provides an opportunity for investors with excess USD cash, or international investors with unhedged exposure to U.S. assets, to reduce their exposure to the U.S. dollar."

Over the long term, UBS sees further structural risks. "The trend of international diversification could lead to further dollar weakness, particularly if the Federal Reserve begins to play a more active role intervening in bond markets amid high fiscal deficits."

Not A Collapse For Now, Yet Caution Is Warranted

The Dollar Index (DXY) – which is tracked by the Invesco DB USD Index Bullish Fund ETF (NYSE:UUP) – fell 0.8% on Monday, erasing gains from last week on the back of a U.S.-China trade truce.

Capital flight hasn't hit the data yet, but concerns about U.S. debt and policy are starting to grow worldwide.

For the time being, the dollar remains the anchor of global trade and finance—but the psychological buffer it once enjoyed is showing cracks, and that shift may matter more than a credit downgrade.

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Image created using artificial intelligence via Midjourney.