US Dollar's Decline Predicted in 2026: Morgan Stanley's Outlook on Currency Volatility

Key Points Summary:

• Morgan Stanley anticipates the dollar to decline by 5% to 94 by mid-2026 before rebounding towards year-end.

• A continuation of the current "USD bear regime" is expected until mid-2026, driven by Fed rate cuts and a softening labor market.

• As the Fed's rate-cutting cycle ends and economic growth improves, European currencies, particularly the Swiss franc, are expected to outperform in the latter half of 2026.

The U.S. dollar's current uptrend is predicted to be short-lived, as Morgan Stanley projects a turbulent 2026 with an anticipated decline in the first half, followed by a potential recovery as the Federal Reserve approaches the conclusion of its rate-cutting cycle.

According to Morgan Stanley’s strategists, the U.S. Dollar Index (DXY) is set to decrease by approximately 5% to 94 by mid-2026 before staging a rebound, reflecting the prolonged "USD bear regime" that has characterized much of this year. This bearish outlook is tied to expectations of U.S. interest rates continuing to converge with international rates, facilitated by three additional rate cuts from the Fed by the end of the first half of 2026 amid a softening labor market.

The Fed’s “proactive dovishness,” even in the face of seasonally influenced consumer price index (CPI) trends, is likely to sustain the weakening momentum of the dollar for an extended period.

A shift in fortunes is anticipated in the latter half of 2026, as the Fed concludes its cutting cycle and U.S. economic growth gains momentum. Morgan Stanley forecasts a rebound in U.S. real rates, ushering in a “carry regime” that would favor cross-currency trades—risk currencies are expected to outperform while funding currencies weaken, placing the USD in a precarious position.

With the emphasis transitioning from a straightforward decline of the dollar to cross-currency trades, the selection of a funding currency will become pivotal in 2026. During the bear phase, the dollar is expected to be favored as a funding currency, despite higher carry costs when compared to traditional funding options like the Swiss franc (CHF), Japanese yen (JPY), and euro (EUR). However, as the carry regime develops later in the year, Morgan Stanley advises that returns will likely favor European currencies, positioning the CHF at the forefront as a preferred funding choice.