GLMS SEC released a research report indicating that while the US dollar is expected to remain in a weak cycle next year, its performance may not be as poor as anticipated. Key risks include potential cautious rhetoric on monetary easing from a Trump-nominated Fed Chair early in the year, and possible economic divergence between the US and non-US economies in the second half. Other factors to monitor include the Bank of Japan's independence and fiscal concerns in high-debt European nations like France.
Recent years have shown that year-end USD forecasts often prove inaccurate. For instance, despite widespread expectations of sustained USD strength amid post-election euphoria and inflation fears in late 2024, the currency peaked in January 2025 and fell over 10% annually. Currently, market consensus suggests USD weakness as the baseline scenario for 2026.
Three factors underpin expectations for USD weakness: 1) Anticipated Fed easing narrowing rate differentials with major economies. Japan's explicit fiscal stimulus and BOJ Governor Ueda's hawkish inflation rhetoric have sharply raised December rate hike expectations, while the ECB remains cautious about cuts. In contrast, the US appears headed for significant easing, with Trump pushing rate cut expectations and leading Fed chair candidate Hassett being a low-rate advocate. 2) Eurozone fiscal expansion, particularly in Germany, boosting the euro. While US fiscal policy may also be active, forex markets focus on marginal changes - Germany's policy shift carries greater symbolic weight, and the US faces higher debt burdens potentially undermining currency credibility. 3) Non-US economic resilience. Major USD counterpart economies like Germany and Japan are in recovery phases, while the US faces growth constraints from prior tightening. Potential US tariff reductions could further ease pressure on non-US economies while worsening US fiscal health.
However, these assumptions contain vulnerabilities: 1) Policy timing mismatches. US easing may be delayed as inflation control remains a political priority ahead of elections, suggesting even a Hassett-led Fed would proceed cautiously. In Japan, Prime Minister Takaichi's Abenomics allegiance and political needs may constrain BOJ tightening. 2) European fiscal fragmentation. While Germany may expand fiscally, high-debt nations like France and Italy likely maintain neutral-to-tight policies. France's political instability - four PM changes in two years over deficit cuts - and 2027 election pressures could trigger fiscal slippage, widening bond spreads with Germany and weakening the euro. 3) Non-US economic cyclicality. The relative advantage of Japan/Europe may not persist all year, with China's economic rhythm being crucial. A synchronized recovery in China and Europe would smooth USD depreciation, otherwise volatility may prevail.
Particular attention should focus on Q3-Q4 2026 for potential inflection points. The US may see economic rebound as the administration boosts fiscal stimulus and rate cuts ahead of midterm elections, while non-US economies could decelerate. China's growth pattern may resemble previous years' "front-loaded" trajectory, and Europe faces spillovers from China and prior currency appreciation.
Key risks: Escalating Russia-Ukraine conflict; worse-than-expected European slowdown; worsening US debt crisis.
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