A dismal year for the U.S. dollar is ending with signs of stabilization, but many investors believe the currency's decline will resume next year as global growth picks up and the Fed eases further.
The U.S. dollar slumped 9% this year, against a basket of currencies (.DXY), opens new tab, putting it on pace for its worst showing in eight years, driven by expectations of Federal Reserve rate cuts, shrinking interest rate differentials with other major currencies, and as concerns about U.S. fiscal deficits and political uncertainty swirled.
Investors broadly expect the dollar to weaken further as other major central banks stand pat or tighten policy and as a new Fed Chair takes charge - a change that is expected to herald a more dovish tilt for the central bank.
The dollar typically falls when the Fed cuts rates as lower U.S. interest rates make dollar-denominated assets less attractive to investors, reducing demand for the currency. "The reality is we still do have an over-valued U.S. dollar from a fundamental standpoint," Karl Schamotta, chief market strategist at global corporate payments company Corpay, said.
Getting the dollar's trajectory right is important for investors, given the currency's central role in global finance. A weaker dollar boosts U.S. multinational earnings by increasing the value of overseas revenues when converted back to dollars, even as it enhances the attractiveness of international markets by providing an FX boost beyond the underlying asset performance.
Despite the dollar's rebound in recent months - the dollar index is up nearly 2% from its September low - FX strategists have largely maintained forecasts for a weaker dollar in 2026, a Reuters survey conducted from Nov. 28 to Dec. 3 showed.
The dollar's real broad effective exchange rate - its value relative to a large basket of foreign currencies, adjusted for inflation - stood at 108.7 in October, down only slightly from a record high of 115.1 in January, showing that the U.S. currency still remains overvalued, according to Bank for International Settlements data.
Expectations for dollar weakness hinge on converging global growth rates with the U.S. advantage expected to narrow as other major economies gain momentum. "I think what's different is that the rest of the world is just going to grow more next year," said Anujeet Sareen, portfolio manager at Brandywine Global.
Germany's fiscal stimulus, China's policy support, and improved growth trajectories in the euro zone are expected to reduce the U.S. growth premium that has supported the dollar in recent years, investors said.
"When the rest of the world is starting to look better in terms of growth, that's favorable for the dollar to continue to weaken," Paresh Upadhyaya, director of fixed income and currency strategy at Amundi, the biggest European asset manager, said.
Even investors who believe the worst of the dollar's decline is over say any major hit to U.S. growth could weigh on the currency.
"If you see any weakness at any point next year, that could probably be bad for markets, but that could definitely affect the dollar too," said Jack Herr, investment analyst at mutual fund company GuideStone Funds, who doesn't foresee major further dollar depreciation as his base case for 2026.
