The U.S. dollar is experiencing its sharpest annual decline since 2017. Major Wall Street banks predict the greenback will weaken further next year as the Federal Reserve continues its interest rate-cutting cycle.
This year, the trade war initiated by U.S. President Donald Trump has sparked concerns about the world's largest economy and led investors to question the dollar's traditional status as a safe-haven currency. As a result, the dollar has fallen 9.6% against a basket of major currencies.
Among major currencies, the euro's gain against the dollar has been the most significant, surging nearly 14% to above $1.17, a level last seen in 2021.
"This is one of the dollar's worst years in the history of floating exchange rate regimes," said George Saravelos, Global Head of Foreign Exchange Research at Deutsche Bank.
The dollar's initial weakening began in April when Trump imposed high tariffs on U.S. trade partners—during which it fell as much as 15% against major currencies before recovering—while the Fed's restart of its rate-cutting cycle in September placed additional pressure on the currency.
Analysts and investors believe the Fed is likely to cut rates again next year, while other major central banks, including the European Central Bank, may hold rates steady or even hike them. This expectation is set to drive the dollar even lower.
Traders anticipate the Fed will implement two to three 25-basis-point rate cuts by the end of 2026. In contrast, ECB President Christine Lagarde stated this month that the ECB has raised its growth and inflation forecasts while keeping rates unchanged, suggesting that "all policy options should remain on the table."
Wall Street banks forecast the euro will rise to $1.20 against the dollar by the end of 2026, while the British pound is expected to climb to $1.36 from its current level of $1.33.
"The Fed is moving against the global central bank trend... it remains in a significant easing mode," said James Knightley, Chief International Economist at ING.
As the world's dominant currency, the dollar's performance has profound implications for corporations, investors, and central banks globally. This year's dollar weakness has been a boon for U.S. exporters but has hurt many European companies with sales in the U.S. market.
Analysts believe the dollar's trajectory in 2026 will also depend on Trump's choice for Fed Chair. If the successor to Jay Powell is perceived as likely to yield to White House pressure for more aggressive rate cuts, the dollar could decline further.
Previous reports indicated that bond investors have expressed concerns to the U.S. Treasury: Powell's term expires in May next year, and one leading candidate, Kevin Hassett, might cut rates to appease Trump.
Under new leadership, investors expect the Fed to become "more interventionist," implement larger rate cuts, and be "more inclined to act on intuition," Knightley said.
If the Fed becomes constrained by the White House, it would reignite market concerns about U.S. policymaking—worries that severely undermined the dollar for weeks after Trump announced his "Liberation Day" tariff plan in April.
"The erosion of the fundamental pillars of dollar dominance by Trump could be a slow, long-term process, but it remains on the minds of market participants," said Mark Sobel, former U.S. Treasury official and U.S. Chairman of the Official Monetary and Financial Institutions Forum (OMFIF).
The dollar has rebounded 2.5% from its yearly low hit in September, partly because earlier predictions that the trade war would cause a U.S. recession failed to materialize.
Dollar bulls argue that the artificial intelligence investment boom will keep U.S. economic growth above European levels next year, thereby limiting the Fed's room for significant rate cuts.
"We believe President Trump's economic policies cannot hinder the technological revolution happening on the U.S. West Coast," said Kit Juckes, Currency Strategist at Societe Generale.
However, analysts warn that even if U.S. stocks continue to rise next year, it may not necessarily boost the dollar.
Despite the dollar stabilizing after the turmoil caused by the "Liberation Day" tariffs, Trump's chaotic policymaking has prompted foreign investors to begin hedging their dollar exposure when purchasing U.S. stocks, analysts said.
Saravelos noted that part of the dollar's weakness stems from "a structural reassessment by global investors, particularly in Europe, of unhedged dollar exposure."
Investors' hedging activities through derivative trades inherently exert downward pressure on the dollar exchange rate.
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