The U.S. dollar (USD) begins the new year at a turning point. After several years of strong development driven by the U.S. growth supremacy, the Fed's aggressive tightening, and repeated moments of global risk aversion, the factors behind the broad strengthening of the dollar have started to weaken, but have not completely collapsed.
FXStreet assesses that the upcoming year is better characterized as a transition phase rather than a clear new era.
Transition year for USD
For the year 2026, the baseline assumption is a moderate softening of the dollar, driven by high beta and undervalued currencies as interest rate differentials narrow and global growth stabilizes. The Fed is expected to cautiously transition to a lighter monetary policy, but the bar for aggressive rate cuts remains high. Stubborn service inflation, a resilient labor market, and an expanding fiscal policy support modest changes in U.S. monetary policy.
In currency markets, this means selective opportunities, not a broad dollar bear market.
Near-term threats include the rise of new fiscal uncertainty in the United States, where government shutdowns may increase momentary volatility and safe-haven dollar demand more than permanently alter the dollar's trend.
In the longer term, the end of Federal Reserve Chair Jerome Powell's term in May brings additional uncertainty, as markets assess whether a potential leadership change could steer policy in a more moderate direction.
The coming year will not therefore conclude the dollar's position, but will require navigation in a world where the dollar's attractiveness is diminished but its role remains central.
The U.S. dollar in 2025: from exceptionalism to fatigue?
Last year was not defined by a single shock but by a steady series of moments that tested and ultimately reinforced the dollar's resilience.
The year began with a strong assumption of a slowdown in U.S. growth and that the Fed would soften its guidance. This forecast was premature, as the U.S. economy remained resiliently strong. Activity held up, inflation slowed only gradually, and labor markets remained tight enough for the Fed to remain cautious.
Inflation rose to be the second recurring challenge. Overall inflation eased, but the developments were uneven, particularly in services. All inflation figures above expectations reignited discussions about how tight policy should be. The result was generally a stronger dollar and a reminder that the phase of disinflation is not yet over.
Geopolitics remained a constant background factor. Tensions in the Middle East, the war in Ukraine, and fragile U.S.-China relations—especially in trade—regularly unsettled markets.
Outside the United States, few challenged the status quo: sentiment in Europe remained subdued, China's recovery was unconvincing, and elsewhere, relative growth weakness limited more permanent dollar weakening.
Additionally, the Trump phenomenon: Politics had less impact as a clear driver of the dollar's direction, and more caused recurring volatility. The timeline below shows that moments of heightened political or geopolitical uncertainty have generally been times when the currency benefited from its safe-haven role.
In 2026, this pattern is unlikely to change. Trump's presidency is more likely to impact currency markets by causing spikes of uncertainty in trade, fiscal policy, or institutions, but not as predictable policy.
Federal Reserve policy: cautious easing, not a directional shift
Federal Reserve policy remains the key factor for the dollar's outlook. There is still stronger confidence in the markets that the peak in the policy rate is already behind us.
Still, expectations for the pace and scale of rate cuts are alive, and many anticipate excess.
Inflation has clearly moderated, but the final phase of slowing continues to proceed slowly, as both headline and core CPI growth remains above the bank's target of 2.0 percent. Service inflation remains high, wage growth cools slowly, and financial conditions have eased significantly. The labor market is no longer overheated but remains strong in historical comparison.
In this situation, the Fed is likely to gradually and conditionally lower rates and not to initiate an aggressive easing cycle.
From a currency market perspective, this matters because interest rate differentials are not narrowing as quickly as markets are currently anticipating.
This means that the dollar's weakening alongside Fed easing is likely to progress in a controlled manner, not through abrupt movements.
The dynamics of public finance and the political cycle
U.S. fiscal policy remains a familiar challenge for dollar outlooks. Large deficits, growing debt issuance, and a deeply divided political climate are no longer temporary features of the cycle but are inherently part of the current situation.
There is a clear tension in the situation.
On one hand, broad fiscal policy continues to support growth, delaying significant slowdowns, and indirectly supports the dollar by bolstering U.S. outperformance. On the other hand, the ongoing growth of government bonds raises legitimate questions about debt sustainability and how long global investors are willing to hold a continuously growing supply.
Markets have been surprisingly calm regarding so-called 'twin deficits.' Demand for U.S. assets remains strong, as investors are attracted by liquidity, yield, and the lack of credible alternatives on a large scale.
Politics adds a new uncertainty factor. Election years—midterm elections in November 2026—generally raise risk premiums and bring short-term volatility to currency markets.
The most recent government shutdown is a good example: although the U.S. government continued to operate after 43 days, the key issue remains unresolved.
Lawmakers have moved the next funding deadline to January 30, so the risk of a new deadlock remains very much in play.
Valuation and positioning: crowded, but not broken
From a valuation perspective, the U.S. dollar is no longer cheap, but it also does not appear particularly overvalued. Valuation alone has rarely been a reliable trigger for reversals in the dollar's cycle.
Market positions tell a more interesting story: speculative positions have clearly turned, and net shorts in the dollar are now at multi-year highs. In other words, part of the market has already taken a position in favor of dollar weakening. This does not yet negate the bearish outlook but changes the risk profile. As positioning becomes increasingly one-sided, a sustained dollar decline requires more, and the unwinding of short positions could lead to strong counter-movements.
This is particularly significant in an environment where policy surprises and geopolitical tensions remain possible.
Overall, a relatively high valuation and strong short positioning do not really support a clear dollar bear market, but rather a more uneven development, where periods of weakness are occasionally followed by rapid and sometimes uncomfortable counter-movements.
Geopolitics remains one of the quietest yet most reliable pillars of support for the U.S. dollar.
Markets are not facing a single geopolitical shock, but a continuous accumulation of small risks.
Middle Eastern tensions remain unresolved, the war in Ukraine weighs on European sentiment, and U.S.-China relations are very fragile. Adding to this are disruptions in global trade routes and escalating strategic competition, keeping uncertainty at a high level.
None of these factors imply that one should invest permanently in the dollar. Together, however, these risks reinforce a familiar pattern: as uncertainty grows and liquidity rises to unpredictable levels, the USD still benefits more from its safe-haven status.
Outlooks for major currency pairs
● EUR/USD: The euro (EUR) may receive some support as the cyclical situation improves and energy supply concerns ease. However, Europe's structural challenges remain. A slow growth trend, limited fiscal policy, and the ECB's likely earlier easing than the Fed constrain upside potential.
● USD/JPY: Japan's gradual shift away from very loose monetary policy could help the Japanese yen (JPY) somewhat, but the yield gap compared to the U.S. remains large, and the risk of official intervention is always present. The market can expect plenty of volatility, two-way risk, and rapid tactical movements instead of a steady and sustainable trend.
● GBP/USD: The pound (GBP) remains in a challenging situation. Growth trends are weak, fiscal maneuverability is limited, and politics creates uncertainty. Valuation helps somewhat, but the UK still lacks a clear cyclical tailwind.
● USD/CNY: China's policy strongly emphasizes maintaining stability rather than stimulus. Pressures on the Renminbi (CNY) have not disappeared, but authorities are unlikely to accept rapid or uncontrolled movements. This approach limits the broader spread of dollar strength across Asia while also curbing the potential of growth market currencies related to the Chinese cycle.
● Commodity currencies: Currencies like the Australian dollar (AUD), Canadian dollar (CAD), and Norwegian krone (NOK) may benefit as risk sentiment improves and commodity prices stabilize. Nevertheless, any potential gains are likely to be uneven and highly sensitive to Chinese economic data.
Scenarios and risks for 2026
In the base scenario (with a 60% probability), the dollar gradually loses value as interest rate differentials narrow and global growth levels off. This is a calm adjustment, not a sharp turn.
A stronger bullish scenario for the dollar (around 25%) would be a familiar outcome: inflation proves to be more persistent than expected, Fed rate cuts are delayed (or do not occur at all), or a geopolitical shock increases demand for safety and liquidity.
The probability of a bearish scenario for the dollar is lower, around 15%. Such a scenario would require a clearer global growth rebound and a stronger Fed easing cycle, which would significantly weaken the dollar's yield advantage.
Additional uncertainty also comes from the change in Fed leadership. Powell's term ends in May, so markets are likely to start paying attention to the successor well in advance of the change.
The perception that the successor could be more dovish may gradually weigh on the dollar by undermining confidence in U.S. real yield support. As with many current outlooks, the impact is likely to be uneven and temporally variable rather than a clear directional shift.
Overall, risks remain skewed towards random periods of dollar strengthening, although the broader trend appears to be moderately downward over time.
US dollar technical analysis
From a technical perspective, the recent withdrawal of the dollar appears more like a pause within a broader price range, rather than a decisive change in direction—at least when viewed through the lens of the US Dollar Index.
At the weekly or monthly level, the situation becomes clearer: DXY remains well above pandemic-era levels, with buyers appearing whenever tensions are visible in the markets.
On the downside, the first important area is around 96.30, representing approximately the lows of the last three years. A clear drop below this level would be significant, bringing the long-term 200-month moving average slightly above the 92.00 level back into consideration.
Below that level, the area below 90.00, last tested during the 2021 lows, would be the next key support level.
Looking upward, the first significant barrier is around the 103.40 level, representing the 100-week moving average. A rise above this level would open up
the opportunity towards the 110.00 area, which was last achieved in early January 2025. When (and if) the later boundary breaks, the post-pandemic peak near 114.80—which was seen in late 2022—could begin to form in the future.
The technical picture supports the broad macro narrative; there is room for decline, but it is unlikely to be smooth or uncontested.
Technical indicators suggest that DXY is likely to remain within a range, tracking changes in sentiment, and is prone to strong counter-movements rather than a straightforward decline.
The coming year is unlikely to conclude the U.S. dollar's central role in the global financial system.
Rather, this is a conclusion of an exceptionally favorable phase, where growth, politics, and geopolitical events supported the dollar.
As these forces balance out, the Greenback loses some height but not its significance. Both investors and policymakers face the challenge of distinguishing between cyclical corrective moves and structural directional changes.
The first option is significantly more likely than the latter.