Dollar keeps losing market share but euro is no winner either: ECB study

An ECB report indicates the dollar's declining market share in global foreign exchange holdings is primarily benefiting smaller currencies and gold, rather than the euro, which has seen only marginal gains. While the dollar's share has decreased by 10 percentage points over the past decade to 58%, the euro's share remains just below 20%, with central banks significantly increasing their gold reserves for diversification and geopolitical risk protection. Despite recent indications of increased investor demand for euro-denominated assets and a rise in U.S. firms issuing debt in euros, the Eurozone's fragmented financial infrastructure and lack of military capabilities hinder its ability to fully capitalize on the dollar's decline.

Analysis

An European Central Bank (ECB) report highlights a continued erosion of the U.S. dollar's market share in global foreign exchange reserves, which stood at 58% in 2024 after a 10 percentage point decline over the past decade and a specific 2 percentage point drop in 2024 alone. This decline has primarily benefited smaller currencies, such as the Japanese yen and the Canadian dollar, and gold, rather than significantly bolstering the euro, whose share has consistently hovered just below 20%. Central banks have notably increased their gold holdings by over 1,000 tonnes last year, a record pace, driven by diversification needs (cited by two-thirds of central banks) and as a hedge against geopolitical risk (cited by two-fifths). Consequently, gold's share in total foreign reserves, at 20%, now surpasses the euro's 16%. Despite these trends, recent market movements since April, including an unusual weakening of the dollar against the euro despite rising U.S. yields, suggest investors may be demanding a higher risk premium for U.S. assets due to concerns over U.S. fiscal policy and debt sustainability. This is further evidenced by a steady stream of U.S. firms issuing euro-denominated debt (reverse Yankee Bonds). However, the report underscores that the Eurozone's structural limitations—specifically a fragmented debt market lacking a large-scale safe asset, an incomplete banking union, the absence of a unified capital market, and insufficient military defense capabilities—hinder the euro's potential to meaningfully challenge the dollar's dominance.

Key Decisions for Investors

• Investors should monitor the accelerating trend of de-dollarization and the associated shift by central banks towards gold and non-traditional currencies for long-term strategic asset allocation.
• Consider diversifying currency exposure beyond the dollar and euro, potentially including assets like gold, the Japanese yen, and the Canadian dollar, reflecting observed central bank preferences and geopolitical hedging.
• Evaluate the heightened risk premium seemingly being demanded for U.S. assets, driven by fiscal concerns, and assess its impact on U.S. dollar-denominated holdings.
• Recognize that despite recent positive signals for euro-denominated assets, significant structural impediments within the Eurozone are likely to limit the euro's capacity to rapidly supplant the dollar as the leading global reserve currency in the near to medium term.