FX Outlook 2026 - More dollar weakness ahead

Introduction

2025 has been a turbulent year for currency markets especially for the US dollar. It has been the weakest performing currency of the majors . The dollar index has fallen by 8% with the declines ranging from only 1% versus the New Zealand dollar to more than 15% versus the Swedish krona. The euro has gained by around 11% versus the dollar. The US administration’s policies have impacted growth prospects, inflation dynamics and expectations about monetary policy. Expectations of more monetary policy easing by the Fed, weaker than expected growth and unfavourable inflation dynamics have weighed on the US dollar. In addition, it is likely that economic policy uncertainty caused by the Trump Administration has also played some role. Moreover, more FX hedging added to dollar weakness. In this publication we focus on our views for 2026 and we added 2027 to our forecast horizon.

More dollar weakness in our forecast horizon

Last week we published our thematic piece on the dollar “Why the dollar is still overvalued” (see more here). The dollar is still overvalued in our view. Both purchasing power parity (PPP) and our own fundamental model estimate point in this direction. PPP helps compare what money can buy in different countries, giving us a better idea of currency value. The graph below on the left shows the results. According to PPP, the dollar is most overvalued compared to the Japanese yen, with a PPP-based overvaluation of about 40%. This measures also implies a 17% overvaluation relative to the euro. The only exception is the CHF, to which the dollar is 19% percent undervalued on a PPP-basis. Using GDP-weights, the PPP analysis suggests a EURUSD valuation of 1.42.

Another estimate of the valuation of the dollar compared to the euro comes from our internal BEER (Behavioural Equilibrium Exchange Rate)-type model, which uses quarterly data to estimate a ‘fundamental value’ of the exchange rate based on macroeconomic fundamentals, including terms of trade, relative yields and relative price levels. The latest available data points to a ‘fundamental’ value of the EURUSD at 1.23 – the highest since 2017 – and up substantially since its low in 2024Q3.

We remain negative on the dollar looking forward due to cyclical factors and structural factors. To start with the cyclical factors, we expect the Fed to become more dovish. This may already be reflected in the price but the risk of an even more dovish tilt on the back of more pressure of President Trump is not. Moreover, a more dovish Fed is not ideal for the inflation outlook (see more here). As a result, real interest rates will likely decline, and this is a negative for a currency.

Next to the cyclical factors we expect the structural factors to gain more attention such as the fiscal deficit and current account deficit. We start with the US fiscal deficit. The US fiscal deficit is on an unsustainable trajectory (see our note here). Concerns about the unsustainable fiscal deficit and government shut down have contributed to dollar weakness via the increase in risk premia meaning that investors wanted a higher compensation for the risk they take. The US not only runs a large fiscal deficit (and even increasing) but also a large current account deficit. Foreigners were willing to finance this deficit because of the special status of US assets and the US dollar. For now, foreign investors seem to hold on to their US assets, but they have started to hedge their exposure or have increased their hedges. If they were to decide to adjust their US asset holdings this could have a significant impact on US asset prices and the US dollar.

Constructive on the euro

In contrast to our dollar view, we are constructive on the outlook for the euro. First, we expect that the ECB will no longer ease monetary policy. As a result, the official rate spread Fed-ECB and real rate spread are set to narrow. This will likely be supportive for the euro. Second, in 2026 higher defence spending and German infrastructure spending are likely to drive quarterly growth higher. However, the fiscal situation in France could dampen the upside in the euro especially versus countries that have more sound fiscal finances such as Switzerland, Norway and Sweden . If the market gets concerned about the fiscal balances, the US is in the most precarious position.

Japanese yen to profit from dollar weakness

The yen is strongly driven by the prospects of returns outside Japan and the hedging costs. As a result, interest rate spreads (nominal and real) are usually a good guide for the direction in USD/JPY and EUR/JPY. However, in June 2025 this relationship broke down. This is because there are more factors to consider such as position overhang (speculators hold large net long positions in yen) and the change in political climate in Japan. Despite this, we judge that these high levels in EUR/JPY (weakness in the yen) are not justified. We expect a recovery of the yen versus the euro in 2026 and a larger rally versus the dollar in 2026. The rate differentials between the US and Japan will probably narrow. Indeed, we expect the Fed to continue to ease monetary policy, while the Bank of Japan is gradually tightening its policies. Furthermore, we expect general dollar weakness also to play out also versus the yen. Finally, net-long speculative positions have been cut in half compared to the peak, so there is room to set up new net-long positions.

Sterling to struggle versus the euro

So far this year sterling has performed well versus the US dollar because of general dollar weakness, but it underperformed versus the euro. The market is concerned about the fiscal situation of the UK and has sold sterling because of this. In addition, some political developments in the UK and the difficult position of the Bank of England because of low growth and relatively high inflation have also been drivers of sterling’s decline. We do not expect fiscal worries to get out of hand in the UK. We expect the UK to comfortably meet market expectations in announcing new revenue-raising measures at the Autumn Statement budget announcement on 26 November, and in our base case, we expect debt to broadly stabilise as a share of GDP, if not decline slightly, over the coming years (see outlook). Therefore, we think that sterling has room to recover, especially versus the US dollar. We expect sterling however to struggle versus the euro in 2026 as we think that the ECB is done with easing monetary policy and for the Bank of England, we expect cuts in 2026. Furthermore, we are optimistic about the growth outlook for the eurozone.

Chinese yuan to rise at a modest pace versus the dollar

The Chinese yuan has had a volatile ride this year. For 2026 we expect the Chinese yuan to perform well versus the US dollar. We expect more aggressive monetary policy easing in the US than in China in our forecast horizon. In addition, China’s economy grows more strongly than the US economy, even though both economies are slowing down. Third, the authorities currently favour a modest appreciation of the yuan. However, higher tensions between the US and China could limit the upside in the yuan or result in some temporary weakness.

Some upward momentum EUR/CHF

The Swiss franc has been one of the best performing currencies of 2025, rallying by 12% versus the dollar and 1% versus the euro. Switzerland has a large current account surplus and a small fiscal surplus, modest economic growth with strong ties to the eurozone economy and inflation far below the central bank target (close to 0%). Official rates are also at zero therefore the central bank remains willing to be active in the foreign exchange market to limit the upside of the already strong and overvalued Swiss franc. We expect our positive outlook for the eurozone economy and the differing monetary policy stance of the ECB and the SNB to result in some upward momentum in EUR/CHF.

Swedish krona and Norwegian krone as diversification alternative

In 2025 both the Swedish krona and the Norwegian krone outperformed the dollar and the euro. We remain modestly optimistic for both currencies over our forecast horizon. As in the case of the ECB, we expect the Riksbank and the Norges Bank to stay on hold for the time being. This is because inflation is still above target in both countries. In addition, the fiscal situation in Norway and Sweden is far better than in the US, the UK and France. This should support these currencies from diversification point of view if financial markets scrutinise the fiscal balances. However, they remain vulnerable if market turns risk averse, if oil and gas prices decline (Norwegian krone) and/or if global trade and growth become more gloomy (Swedish krona). Our energy analyst expects substantial weakness in oil and gas prices, and this will take some of the shine off the Norwegian krone.

Not the ideal environment dollar bloc currencies

The Australian dollar, New Zealand dollar and the Canadian dollar are currencies that perform well in an environment of strong global growth, strong global trade, higher domestic rates and risk-on environment in financial markets. This is not the environment that we expect for 2026. But these countries have modest growth, and their central banks are reluctant to ease monetary policy aggressively in 2026 (some have already done so in 2025). In addition, these currencies will likely profit from the general dollar weakness that we expect and have better current account and fiscal balances. Canada is the most sensitive to policy changes in the US and is facing quite high tariffs rates from the US. Therefore, we are more negative on the Canadian economy the Canadian dollar compared to the other two dollar bloc currencies.

Polish złoty to stay in a range for the time being

The Polish economy is relatively strong (GDP growth 3.4% y/y in Q2 2025). Inflation has declined and is now within the central bank’s target range. The monetary policy objective has been to target inflation (CPI) at 2.5% with a symmetric band for deviations of +/-1 percentage point in the medium term. In 2025 the central bank lowered the official rate by 150bp, from 5.75% to 4.25% per 4 November. The central bank is data dependent. Since April, EUR/PLN has been moving in a 4.2-4.3 range. A relative strong economy and relatively high interest rates in Poland support the currency, while political uncertainty and uncertainty about Russia’s next actions weigh on the currency. Therefore, our forecasts are relatively neutral.

Yield attraction for the Brazilian real

The BRL has performed well in 2025. Indeed USD/BRL has declined from 6.20 to 5.35 or -13.5% mainly because of a relatively strong economy, higher interest rates, strong positive real yields as well as general weakness in the dollar. Inflation expectations remain above the inflation target across all horizons. The central bank has an inflation target of 3.0%, with a tolerance interval of ± 1.50 percentage points. With inflation above target and strength in the labour market, the central bank hiked the policy rate to 15% in June 2025, the highest level since 2006. Since then, the central bank has been data dependent, and it left rates on hold on 5 November. However, the central bank will likely ease in 2026 and this could reduce the attractiveness of the real. Moreover, developments on the political front could result in temporary weakness in the currency. So, we have a modest upside for the real during our forecast horizon.