The U.S. dollar has endured a dismal year in 2025, falling nearly 9% against a basket of major currencies, marking its worst performance in eight years. Despite signs of stabilization in recent months, many investors expect the dollar’s decline to continue into 2026, driven by global economic growth, Federal Reserve rate cuts, and persistent concerns over U.S. fiscal deficits and political uncertainty.

Dollar Decline Fueled by Fed Policy and Overvaluation

The U.S. dollar’s slide this year has been largely influenced by expectations of Federal Reserve interest rate cuts. Lower U.S. rates reduce the attractiveness of dollar-denominated assets, decreasing demand for the currency.

Karl Schamotta, Chief Market Strategist at Corpay, noted:

“The reality is we still do have an over-valued U.S. dollar from a fundamental standpoint.”

The real broad effective exchange rate—which measures the dollar’s value relative to a basket of foreign currencies, adjusted for inflation—stood at 108.7 in October, slightly down from a record high of 115.1 in January, underscoring the dollar’s persistent overvaluation.

Global Growth to Weaken Dollar Advantage

Investors expect the dollar to weaken further as global growth converges with the U.S., narrowing the growth premium that has historically supported the currency. Improved economic performance in Germany, China, and the Eurozone is expected to reduce the U.S. advantage, creating headwinds for the dollar in 2026.

Anujeet Sareen, portfolio manager at Brandywine Global, said:

“The rest of the world is just going to grow more next year, which is likely to weaken the dollar.”

Similarly, Paresh Upadhyaya, Director of Fixed Income and Currency Strategy at Amundi, emphasized that stronger growth abroad favors a continuing dollar decline.

Central Bank Divergence Puts Pressure on Dollar

The Federal Reserve is anticipated to continue rate cuts, while other major central banks, including the European Central Bank (ECB), are likely to maintain or even tighten policy. This divergence typically weighs on the dollar.

With Jerome Powell set to step aside and President Trump’s appointee expected to take over as Fed Chair, market expectations point toward a more dovish central bank. Candidates such as Kevin Hassett, Kevin Warsh, and Chris Waller have expressed support for lower interest rates.

Eric Merlis, Co-Head of Global Markets at Citizens, stated:

“The trend is toward lower growth and weaker employment, which is bearish for the U.S. dollar relative to other G10 currencies.”

Short-Term Dollar Rebound Possible

Despite long-term expectations of weakness, the dollar could see a near-term rebound in early 2026. Factors such as:

• Investor enthusiasm for artificial intelligence driving capital flows into U.S. equities
• Boosts to U.S. growth from government reopenings and recent tax cuts

…could temporarily support the dollar, though analysts caution these are unlikely to be sustained drivers for the currency throughout the year.

Implications for Investors

The U.S. dollar’s performance is critical for global investors, as a weaker dollar:

• Enhances U.S. multinational earnings by increasing overseas revenue value
• Boosts the attractiveness of international markets through favorable foreign exchange effects

However, persistent political uncertainty, fiscal deficits, and global growth dynamics make forecasting the dollar’s trajectory in 2026 challenging.

Conclusion: Weak Dollar Likely Continues

While the dollar may stabilize in the short term, fundamental factors point toward continued weakness in 2026. Investors are advised to monitor Fed policy, central bank divergence, global growth trends, and U.S. fiscal developments to navigate the currency’s outlook effectively.