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The US dollar is headed for its sharpest annual decline since 2017, with Wall Street banks predicting further weakness next year as the Federal Reserve moves to cut interest rates.
The greenback has fallen 9.5 percent against a basket of major currencies this year after US President Donald Trump’s trade war stoked fears for the world’s largest economy and cast doubt on the dollar’s traditional status as a haven for investors.
The euro had the biggest gain among major currencies against a faltering dollar, rising nearly 14 percent to above $1.17, a level last reached in 2021.
“This has been one of the worst years for the dollar’s performance in the history of free-floating exchange rates,” said George Saravelos, global head of FX research at Deutsche Bank.
While the dollar’s initial weakness was triggered by Trump’s introduction of aggressive tariffs against America’s trading partners in April – it was down 15 percent against major currencies before gaining some ground – the Fed’s resumption of rate cuts in September has kept it under pressure.
The prospect of the Fed lowering rates again next year, while other central banks, including the European Central Bank, will pause or raise borrowing costs will weigh on the dollar, according to analysts and investors.
Traders expect the Fed to cut rates by two or three quarterly points by the end of 2026. In contrast, ECB chief Christine Lagarde said this month that “all options should remain on the table” as the central bank kept rates on hold but raised its growth and inflation forecasts.
Wall Street banks expect the euro to strengthen to $1.20 by the end of 2026 and the pound to rise to $1.36 from its current level of $1.33.
“The Fed is bucking the trend across global central banks… it’s still largely dovish,” said James Knightley, chief international economist at ING.
The performance of the dollar, which is still the world’s leading currency, has an impact on companies, investors and central banks. Its weakness this year has been a boon for US exporters, but a hindrance for many European companies generating sales in the US.
Analysts argue that the currency’s fortunes in 2026 will also be shaped by Trump’s choice for Fed chair, with the dollar likely to decline further if Jay Powell’s successor is seen as likely to bow to the White House’s demands for deeper rate cuts.
Bond investors have told the U.S. Treasury they are worried that Kevin Hassett, one of the leading candidates to succeed Powell when his term ends in May, will lower rates to appease Trump, the Financial Times reported this month.
Under the new chair, investors are ready for a Fed that is “more interventionist,” more aggressive in rate cuts and “more willing to move on internal instincts,” ING’s Knightley said.
The Fed, tied to the White House, reignited fears over US policymaking in the weeks following Trump’s “Liberation Day” tariff announcement in April, which weakened the dollar.
Mark Sobel, a former Treasury official and US president of the think-tank OMFIF, said: “Trump’s erosion of the fundamental pillars of dollar dominance may be a very slow, long-term burn, but it still has an impact on the minds of participants.”
The dollar has jumped 2.5 percent from its low in September, partly because forecasts that the trade war would send the US economy into recession failed to come true.
Dollar bulls say the U.S. economy will continue to grow faster than Europe next year on the back of a surge in artificial intelligence investment, limiting room for the Fed to cut rates aggressively.
Kit Juckes, currency strategist at Societe Generale, said: “We do not believe that President Trump’s economic policy can derail the tech revolution underway on the US West Coast.”
But analysts warned that further gains in US stocks next year would not provide a boost to the greenback.
While the dollar stabilized after the “Liberation Day” turmoil, analysts said Trump’s chaotic policymaking has led foreign investors to begin reducing their exposure to the dollar when buying US stocks.
Deutsche Bank’s Saravelos said the dollar weakness was partly due to “a structural reassessment of unhedged dollar exposures by global investors, particularly in Europe.”
Placing hedges, which investors do through derivatives trades, puts downward pressure on the dollar.
