The grand narrative of "de-dollarization" that dominated markets last year appears to have stalled in 2026. Looking in the rearview mirror, there are ample reasons for the dollar's recent strength: a rebound in US economic growth from late last year, geopolitical conflicts pushing up energy inflation, and a subsequent repricing of Federal Reserve rate hike expectations.

Beyond these overt factors, however, a more subtle structural evolution is underway in the global dollar flow mechanism, providing an underappreciated floor of support for the greenback. Notably, asset allocation behavior is diverging between overseas private sectors and official institutions, including foreign central banks. In the tug-of-war between these two forces, dollar buying is unlikely to truly dry up even as the de-dollarization story persists, which explains the disconnect between narrative expectations and currency market reality.

Structural Shifts in the Global Dollar Flow Mechanism

Under the current international monetary system, dollar hegemony relies on a self-reinforcing cycle of "liquidity creation and capital repatriation." Global entities and financial sectors are deeply functionally dependent on the dollar for trade settlement, foreign exchange reserves, cross-border financing, and more. This compels the US to act as the world's ultimate liquidity provider through sustained current account deficits, outward capital flows, and credit expansion. Once distributed and absorbed through global supply chains and cross-border financial networks, these offshore dollars typically return to US financial markets, driven by safe-haven demand and yield-seeking motives, completing a closed-loop of "outflow, absorption, reallocation, and return."

However, we have recently observed structural changes in this dollar liquidity cycle. Regarding who absorbs the dollar outflows, overseas private sectors are replacing official institutions as the core force for dollar absorption and allocation. In the traditional model, official institutions served as the primary receptacle for offshore dollars. The US exported dollars through trade deficits, and overseas entities, upon earning dollars, mostly converted them into local currency through their central banks, with these dollars eventually becoming foreign exchange reserves.

A prominent recent shift, and our first key observation, is the growing trend of "private sector dollar retention," which strengthens private dollar allocation. Companies and financial institutions are no longer fully converting their earned dollars into local currency; instead, they retain, hold, or allocate a portion for cross-border asset allocation, gradually boosting private sector support for the dollar. The migration of offshore dollar holders from central banks to private entities also shifts the logic of dollar flows from central bank-led reserve management to being driven by private sector profit expectations and risk appetite.

This structural feature is clearly confirmed by two sets of data. First, the share of dollars in global central bank reserves continues to decline. Under the "private retention" trend, the scale of dollars recovered by central banks through forex settlement is shrinking, though this decline also includes active reserve diversification by central banks. Notably, the falling dollar reserve share has not driven the dollar index lower, showing a significant divergence in their correlation in recent years. This suggests that a decline in the dollar's share of official reserves does not equate to a simultaneous contraction in global dollar transaction and financing demand; other forces are underpinning the dollar's performance.

Second, the share of US long-term securities held by official versus private sectors is diverging at an accelerating pace. Historically, in 2008, official holdings were about 33% and private sector 67%. Between 2008 and 2020, the official share only modestly declined by 5 percentage points to 28%, a relatively gradual change. But in the last five years, the divergence has sharply intensified, with the official share rapidly falling to 17% while the private sector share rose to 83%. This structural shift confirms a clear change in the holders of offshore dollar assets, with private entities progressively replacing official reserves as the dominant force in US long-term securities. This also explains why, despite the persistent official "de-dollarization" narrative and falling reserve share, the deep foundations of the dollar system remain unshaken—a testament to the growing importance of "private retention" and private allocation.

Why has "private retention" accelerated since 2020? We believe this is linked to the current global AI industry wave. The expansion of the US trade deficit is largely driven by massive capital expenditures on AI data center construction, computing chip purchases, and hardware supply chains.

The rigid dollar demand from overseas tech companies for future AI capital expenditure has created a "closed loop" for the dollar outside the Americas. Overseas suppliers are delaying currency conversion because the next steps in the AI industry chain remain highly dependent on the US tech ecosystem. Whether purchasing high-end software services, leasing cloud computing power, paying patent licenses, or setting up R&D centers in the US, payments must be made in dollars. This leads to dollars flowing out due to US deficits not entering the forex market as dollar sell orders but instead circulating "offshore—retained—reinvested into the US tech ecosystem," making the dollar largely immune to the downward pressure trade deficits would typically exert on its exchange rate.

A clear contrast can be seen in the exchange rate performance of China and South Korea. Both are strong export economies benefiting from the semiconductor cycle, yet since last year, the Chinese yuan and the South Korean won have diverged significantly: the yuan has steadily appreciated against the dollar, while the won remains weak.

The core issue is that foreign exchange created by South Korea's current account surplus is not fully returning to the domestic market. Major companies like Samsung Electronics and SK Hynix have global operations and branches, with much of their trade settled in dollars. Some of their dollar revenues from overseas sales are retained in offshore accounts, mainly for overseas expansion, equipment capital expenditures, and similar purposes, with no urgent need to repatriate all funds to South Korea. Data shows that corporate foreign currency deposits in South Korea have been steadily rising since 2024, reaching $113.3 billion by June 2026.

In contrast, forex settlement by Chinese companies is visibly increasing. China's monthly goods trade surplus has remained around $100 billion, providing a solid fundamental basis for yuan appreciation. Combined with a significant recovery in corporate settlement willingness, settlement behavior and yuan appreciation are forming a positive cycle. Recently, the six-month moving average settlement ratio for goods trade has hit near a decade high, and monthly forex settlement surpluses have remained at or above 200 billion yuan since 2026. However, even in China, companies do not settle all their forex earnings. Estimating via the "foreign-related receipts and payments surplus minus forex settlement surplus" gap, cumulative unsettled funds have reached approximately $130 billion from the start of the yuan depreciation cycle in 2022 to June 2026; for goods trade alone, unsettled funds are even higher, around $1.2 trillion. The "private retention" trend is objectively present here as well.

The second major shift is in the path of dollar repatriation. As noted, private sectors are increasingly the core holders of offshore dollars and correspondingly the main force for repatriation. In the traditional framework, repatriation relied primarily on financial investments like bonds and stocks. But private and official sectors differ significantly in their asset allocation logic.

Official reserve allocation prioritizes safety and liquidity, focusing heavily on low-risk sovereign assets like US Treasuries, with counter-cyclical trading behavior. Even with fluctuations in Treasury yields, central banks generally avoid large-scale selling due to reserve preservation and external payment needs, typically making only gradual adjustments to their dollar asset share. Private sectors, conversely, focus on risk-adjusted returns and exhibit significant pro-cyclical behavior. Private entities can either repatriate funds to the US to allocate in Treasuries, stocks, and credit, or keep dollars offshore to subscribe to overseas dollar bonds, extend cross-border credit, or make overseas direct investments. This means dollar repatriation is no longer a simple one-way loop but has branched into multiple paths: returning to the US or remaining offshore to continue generating dollar credit. Regardless of the path, as long as market participants are willing to hold dollars, the currency gains strong underlying support.

With the rising volume of private dollar holdings, the core foundation for holding and allocating dollars comes from the sustained relative attractiveness of dollar assets. This not only explains the dollar's resilience but also reshapes the holding structure of global dollar assets, leading to two core developments. On one hand, private sectors are replacing official institutions as the core holders and stabilizers of the US Treasury market. As central banks worldwide diversify reserves and reduce Treasury holdings, traditional official support is weakening. But private capital has actively absorbed the Treasuries sold by official institutions, stabilizing the overall size and liquidity of the Treasury market through market-driven allocation, effectively filling the supply gap and ensuring smooth market operation.

On the other hand, the excess returns of US equity assets continue to strengthen global private sector preference for dollar allocation. This AI industry wave has reshaped the profitability logic of US tech companies, driving the stock market higher and showcasing the strong yield elasticity of dollar equity assets. Compared to lower-yield, stable bonds, high-growth, high-return US stocks are far more attractive to private capital. The structural divergence in stock and bond returns persistently guides global private capital toward dollar-denominated assets, further cementing the dollar's demand base and supporting its strength independent of official reserve trends.

This leads to the third key shift. When the private sector accumulates significant dollars and rushes into high-yield assets like US stocks, market profit-seeking behavior fully emerges, and leverage manifests in the currently hot carry trade. In a classic carry trade framework, the dollar often serves as the low-interest borrowing currency due to its monetary policy flexibility and mature market depth. But in this cycle, with high interest rates and AI-driven equity valuation premiums, dollar assets have delivered both interest income and capital gains, offering superior relative returns. This market logic transmits through two core channels, creating a reinforcing effect.

First, there is two-way cross-border capital flow and re-leveraging. Overseas private institutions either borrow low-yield non-dollar currencies like the yen or Swiss franc, converting them into dollars to allocate in US stocks, high-yield Treasuries, and dollar credit assets, or they directly use massive offshore dollar deposits as collateral, using repos and over-the-counter derivatives to further leverage positions. Second, this fosters a self-reinforcing dollar appreciation spiral. Carry trade activity drives large-scale spot and derivative operations of "selling non-dollar currencies, buying dollars," creating sustained trading demand for the dollar. The continued inflow of private leveraged funds pushes up the dollar and US equity valuations, forming a complete positive feedback loop: high returns attract leveraged carry funds, leading to dollar strength and higher risk asset valuations, which in turn attract more carry funds.

Japan exemplifies this dynamic. With long-term low interest rates and a persistently weak yen, the yen's role as the core funding currency for global carry trades has been pushed to the extreme, providing strong support for the dollar. Global hedge funds and other non-bank institutions massively borrow cheap yen, convert to dollars, and add to US stock and high-yield Treasury positions. This "sell yen, buy dollar" leveraged flow boosts dollar and US equity valuations while also inflating offshore yen debt—BIS data shows bank claims on yen owed by non-bank entities outside Japan have risen to around $270 billion, reflecting deep participation in this positive feedback loop by cross-border leveraged funds.

In summary, we can draw three conclusions. First, overseas private sectors have become the core holders of dollar assets. Forex positions have shifted from central bank balance sheets to enterprises and households, so changes in foreign exchange reserves can no longer fully capture the true scale of dollar assets across society. Second, with official sectors reducing Treasury holdings, overseas private sectors have absorbed some of that demand; more importantly, their allocation scope now extends beyond fixed income, with a significant shift toward high-elasticity risk assets like US stocks amid the tech wave, markedly raising risk appetite in cross-border asset allocation. Third, leverage behavior, exemplified by carry trades, amplifies the entire transmission chain, cementing the dollar's pivotal role in private cross-border asset allocation. The expansion and contraction of private dollar positions now not only affect reserve scales but also directly influence capital flows in overseas stock and bond markets, serving as a key link between domestic liquidity and overseas risk assets.

Behind this evolution is a structural restructuring of cross-border capital allocation: the allocation entity has shifted from official to private sectors, the asset mix has migrated from US Treasuries to high-elasticity equities like US stocks, and carry trade leverage has amplified the transmission mechanism.

Two Forces Shaping the Dollar: Fiscal vs. Tech

This profound shift in the dollar flow mechanism essentially reflects the battle between two core forces in the current global market: US fiscal constraints and the AI technology wave. The former acts as a downward pull on the dollar, while the latter provides key upward support. On the fiscal side, continued US fiscal expansion raises Treasury supply, and combined with official sector selling, long-end Treasury supply pressures push up term premiums, exerting downward pressure on the dollar. Meanwhile, the AI wave brings dual benefits of higher US corporate earnings and valuations, persistently attracting global private dollar funds into equity markets, and the appeal of high-yield assets in turn supports dollar demand.

The ebb and flow of these two forces determines the dollar's trading range and deeply influences the opening, rolling, and unwinding of private carry trades. When fiscal supply pressures dominate, the dollar tends to weaken; when tech-driven return attractiveness prevails, funds keep flowing back into dollar assets, giving the dollar strong support. This also suggests that "de-dollarization" is by no means a linear historical process—while official sectors continue reserve diversification to mitigate political and financial risks, private sectors, driven by profit instincts, are continuously strengthening their dollar allocation networks.

However, we believe the inherent risks in this current dollar system cannot be ignored. While the private sector-dominated dollar cycle has, in the short term, successfully offset the downward pressure from de-dollarization and trade deficits through offshore dollar retention, the capital appeal of the AI-driven US stock market, and the pro-cyclical boost of carry trade leverage, maintaining the superficial resilience of dollar hegemony, we must be wary of the significant internal fragility lurking within this new system. Compared to official sectors, which operate on principles of safety, liquidity, and counter-cyclicality, private sector allocation is highly pro-cyclical and sensitive.

During upturns, in a self-reinforcing spiral, private capital pro-cyclically leverages up carry trades and aggressively allocates to dollar assets like Treasuries and stocks, greatly amplifying the system's operational tension and asset valuations. During downturns, in a stampede and liquidity squeeze, if the macro environment reverses—such as an unexpected Fed tightening, sharp Treasury yield volatility, a correction in high US equity valuations, or a spike in offshore funding costs—a large number of highly leveraged, sensitive private positions face forced liquidation and concentrated stop-losses. This collective behavior can trigger violent swings in cross-border capital, amplifying volatility in overseas asset markets and feeding back into global forex and cross-border liquidity conditions, which is a source of fragility in the current dollar system.

In conclusion, we argue that the stability foundation of this private sector-dominated dollar liquidity system has evolved from traditional "national credit and official reserves" to "market sentiment and asset returns." This pro-cyclical cycle built on profit-seeking capital and carry trade leverage will significantly amplify volatility in overseas asset markets and, in turn, destabilize global forex and offshore liquidity conditions. While the offshore dollar system enjoys short-term high-yield support, it is also facing more severe and unpredictable tail risks and volatility tests than in the era of central bank dominance.

This article is sourced from Chuan Yue Global Macro.