The U.S. dollar has barely budged this year - but that could be about to change

MW The U.S. dollar has barely budged this year - but that could be about to change

By Isabel Wang

Currency traders are not convinced that high interest rates are here to stay

Currency traders are not convinced that high interest rates are here to stay.

The U.S. dollar has had every reason to soar in 2026: solid economic growth, a strong stock market, and geopolitical risks stemming from the Iran war. Yet the greenback has only barely ticked higher.

Yet there's reason to believe that's about to change, as hopes are fading that President Trump's pick to lead the Federal Reserve will keep interest rates low.

Fed-funds futures and the bond markets are increasingly pricing in the possibility that the Fed won't cut its benchmark interest rate in 2026 - and that policymakers may even be considering a rate hike. The odds of at least one 25-basis-point rate increase this year have climbed to above 30%, from virtually zero just two weeks ago, after consumer-price inflation surged to a three-year high due to rising oil prices (CL00) (BRN00) brought on by the Iran war.

Higher-for-longer interest rates typically support the dollar. That's because higher rates make U.S. assets such as Treasury bonds and money-market funds more attractive to foreign investors. To buy such assets, those investors first have to buy dollars, driving up demand for the buck.

But for many analysts, the dollar's stubborn stagnation so far this year has a simple explanation: Unlike other parts of the financial markets, currency traders are not convinced that high interest rates are here to stay.

The ICE U.S. Dollar Index DXY, a measure of the dollar's strength against six major rivals, has inched up 0.6% in 2026, but has fallen 1.1% since the end of March. The world's reserve currency has spent much of the year stuck in place and has remained flat year to date, despite a brief uptick in March when safe-haven demand surged amid the outbreak of the Iran conflict.

"The lack of Fed expected hikes appears to be holding the USD back," said Alex Cohen, senior G-10 FX strategist at BofA Global Research. "The energy-induced global inflation shock has resulted in hikes getting priced into many G-10 central-bank curves, though the [U.S. foreign exchange] market remains reluctant to price the Fed to hike in a meaningful way."

Christoph Schon, lead principal of investment-decision research at SimCorp, said there's significant uncertainty about the future direction of monetary policy mainly because it's unclear how Kevin Warsh - confirmed Wednesday as the new chair of the Fed, succeeding Jerome Powell - will approach policy at his first Federal Open Market Committee meeting next month.

"Obviously [Warsh] will be faced with resurging inflation, which argues for higher interest rates, but he's also been appointed by Donald Trump, who put a lot of pressure on the Fed to cut rates," Schon told MarketWatch in a phone interview on Thursday. "That's part of the uncertainty surrounding the dollar at the moment."

See: There are plenty of reasons the dollar should be rallying right now - but it isn't. That's not a good sign.

To be sure, the greenback's stagnation is not a simple story. The dollar has been caught in an unusual tug-of-war between the macro market forces that should be lifting it and a set of growing headwinds from rival currencies such as the Chinese yuan (USDCNY), the Japanese yen (USDJPY) and the euro (EURUSD).

China's yuan on Thursday edged up to a three-year high against the dollar after Chinese president Xi Jinping pledged to further open up the world's second-largest economy during the U.S.-China summit in Beijing - strengthening the yuan's appeal as an international currency. The yuan has also risen for nine consecutive sessions and is on pace for its longest winning run since December, according to brokerage Tullett Prebon.

But the yuan is not included in the benchmark U.S. dollar index that tracks the buck against six major rivals: the euro, the yen, the Canadian dollar (USDCAD), the British pound (GBPUSD), the Swedish krona (USDSEK) and the Swiss franc (USDCHF). That means the dollar could be under even more pressure than the index suggests.

Earlier this month, the yen logged its best week against the dollar since Feb. 13, after Japan's government and the Bank of Japan reportedly carried out an estimated $35 billion currency intervention for the first time in two years. For the year, the yen has weakened just 0.9% against the dollar, according to FactSet data.

Still, Cohen and his team at BofA Global Research see more upside to the dollar, noting that negative sentiment toward the greenback feels stretched.

"Looking through the lens of strong U.S. economic data, equity outperformance, risks of eventual Fed hikes and relatively clean positioning on aggregate, it's striking to us how low USD sentiment appears," they wrote in a Wednesday client note.

"Clearly the market is more focused on the prospect of war resolution and expectations for a dovish Fed, but in the near term, we question how much lower this can take the USD, leaving the balance of risks pointing to the upside," they added.

-Isabel Wang

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May 15, 2026 07:30 ET (11:30 GMT)

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