The U.S. dollar, after a dismal year, shows signs of stabilization toward year-end, but most investors anticipate renewed declines in 2026 as global growth accelerates and the Federal Reserve further eases monetary policy.
Driven by expectations of Fed rate cuts, narrowing yield differentials with other major currencies, and concerns over U.S. fiscal deficits and political uncertainty, the dollar index has fallen 9% this year—its worst annual performance in eight years.
Market consensus points to further dollar weakness. While other major central banks are likely to hold rates steady or even hike, the Fed is preparing for a leadership transition expected to signal a more dovish policy tilt. Typically, Fed rate cuts weigh on the dollar by reducing the appeal of dollar-denominated assets.
"Fundamentally, the dollar remains overvalued," said Karl Shamota, Chief Market Strategist at Corpay, a global corporate payments provider.
Given the dollar's central role in global finance, accurately gauging its trajectory is critical for investors. A weaker dollar boosts profits for U.S. multinationals by increasing the converted value of overseas earnings, while also enhancing the attractiveness of international assets through currency gains.
Despite a 2% rebound from September lows, most FX strategists in a late-November to early-December Reuters poll maintained 2026 bearish dollar forecasts. BIS data shows October's real broad dollar index at 108.7—below January's record 115.1 but still in overvalued territory.
**Global Growth Convergence** A key bearish argument centers on narrowing growth differentials, as recoveries in other major economies erode the U.S.'s prior outperformance. "The game-changer is faster growth elsewhere next year," said Anujit Sareen, Portfolio Manager at Brandywine Global.
Investors cite Germany's fiscal stimulus, China's countercyclical measures, and improving Eurozone prospects as factors diminishing the "U.S. growth premium" that supported the dollar. "Dollar weakness tends to persist when global growth prospects brighten," noted Pareesh Upadhyaya, Head of Fixed Income and FX Strategy at Amundi, Europe's largest asset manager.
Even those believing the worst dollar declines are over acknowledge that significant U.S. economic softening could renew pressure. "Any material U.S. slowdown would hit both markets and the dollar," said Jack Hull, Investment Analyst at Cornerstone Funds, though he views sharp 2026 depreciation as non-base-case.
**Policy Divergence Widens** Expected Fed easing against other central banks' steady/higher rates may further pressure the dollar. The divided Fed cut rates in December, with median projections suggesting another 25bps reduction next year. As Jerome Powell departs, President Trump's nominee—likely from a pool of dovish candidates including Kevin Hassett, Kevin Warsh, and Christopher Waller—could steer policy toward greater accommodation.
"Despite limited expected Fed moves, we see U.S. growth slowing and labor markets weakening," said Eric Morris, Co-Head of Global Markets at Boston Citizens Bank, which is short the dollar against G10 currencies. Meanwhile, traders largely expect the ECB to hold rates through 2026, though hikes aren't ruled out after it upgraded some growth/inflation forecasts in December.
**Bumpy Road Ahead** Investors caution that while structurally bearish, the dollar could see near-term rebounds. Continued AI-driven capital inflows to U.S. equities may provide temporary support. Sareen notes post-shutdown normalization and tax cuts could lift the dollar in Q1 2026, but adds: "We doubt such positives can sustain dollar strength all year."
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