The euro trails far behind the dollar as the world’s main reserve currency. However, with Germany leading Europe toward looser fiscal policies, the single currency now has a rare chance to close the gap. This comes at a time when President Trump’s policies are weakening the dollar’s traditional safe-haven appeal, according to Capital Economics.
Typically, when markets become unstable, investors turn to the dollar for safety. But since Trump’s second term began, the dollar has dropped sharply. Capital Economics analysts say this shows the dollar is losing its charm as a low-risk refuge. Instead, investors appear to be looking more toward the euro.
Despite this potential boost, the euro’s growth as a reserve currency faces three major hurdles. First, economic growth in the eurozone remains weak, which hurts confidence in the currency. Second, the eurozone’s bond market is fragmented, limiting liquidity and scale. This makes euro assets less attractive. Third, there is a shortage of safe assets like German Bunds and shared EU debt, which are key for a reserve currency.
These challenges could soon lessen. Germany’s move to relax strict fiscal rules and increase defense and public spending, along with the EU’s more flexible budget rules, might mark a turning point.
Capital Economics notes that the supply of euro-denominated bonds from highly rated governments and institutions is expected to rise significantly in the coming years. Germany is likely to borrow more due to higher public spending. Meanwhile, the EU’s common debt market could grow to over €900 billion by 2026, up from around €60 billion in 2019.
Still, analysts warn that the dollar’s strong advantages — including the size and depth of U.S. financial markets and its institutional credibility — mean the greenback will remain dominant for now.
They do not expect recent market swings to end the dollar’s status as the global reserve currency. However, they predict the dollar’s share of global reserves will slowly decline. At the same time, the euro’s share is likely to rise.
While the euro won’t replace the dollar overnight, Germany’s fiscal shift and changing global conditions give it the best chance in years to close the reserve currency gap. This is especially true as U.S. policy uncertainty chips away at the dollar’s safe-haven reputation that has lasted since the 1940s.
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