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The US dollar is heading for its steepest annual drop since 2017, with Wall Street banks predicting further weakness next year as the Federal Reserve presses ahead with interest rate cuts.
The greenback has slumped 9.5 per cent against a basket of major currencies this year, after US President Donald Trump’s trade war sparked fears for the world’s biggest economy and cast doubt over the dollar’s traditional status as a haven for investors.
The euro has had the biggest gain of the major currencies against the faltering dollar, surging nearly 14 per cent to above $1.17, a level last reached in 2021.
“This has been one of the worst years for dollar performance in the history of free-floating exchange rates,” said George Saravelos, global head of FX research at Deutsche Bank, referring to the more than half-century during which currencies’ values have been set by the market rather than tied to gold.
While the dollar’s initial weakness was triggered by Trump’s launch of aggressive tariffs against the US’s trading partners in April — it was at one point down 15 per cent against major currencies before regaining some ground — the Fed’s resumption of rate cuts in September has kept it under pressure.
The prospect of the Fed reducing rates again next year while other central banks, including the European Central Bank, hold or even raise borrowing costs, will drive the dollar lower, according to analysts and investors.
Traders expect two or three quarter-point cuts from the Fed by the end of 2026. By contrast, ECB chief Christine Lagarde said this month that “all options should remain on the table” as the central bank held rates 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 climb from its current level of $1.33 to $1.36.
“The Fed is bucking the trend in terms of global central banks . . . it is still very much in easing mode,” said James Knightley, chief international economist at ING.
The performance of the dollar, which is still the world’s dominant currency, has repercussions for companies, investors and central banks. Its weakness this year has been a boon for US exporters but a drag for many European companies that generate sales in the US.
The currency’s fortunes in 2026 will also be shaped by Trump’s pick for Fed chair, analysts argue, with further declines likely for the dollar if Jay Powell’s successor is seen as likely to bow to White House calls for deeper rate cuts.
Bond investors have told the US Treasury they are concerned that Kevin Hassett, one of the leading candidates to succeed Powell when his term expires in May, would lower rates to please Trump, the Financial Times reported this month.
Under a new chair, investors are braced for a Fed that is “more interventionist”, more aggressive in rate-cutting and “more inclined to move on gut instinct”, said ING’s Knightley.
A Fed shackled to the White House would reignite fears over US policymaking that undermined the dollar in the weeks following Trump’s “liberation day” tariff announcement in April.
Mark Sobel, a former Treasury official and US chair of 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 weighs on participants’ minds.”
The dollar has bounced 2.5 per cent off the low for the year it touched in September, in part because predictions that the trade war would drive the US economy into recession have failed to materialise.
Dollar bulls say that the artificial intelligence investment boom will keep the US economy growing faster than Europe’s next year, limiting the Fed’s room to cut rates aggressively.
Kit Juckes, currency strategist at Société Générale, said: “We don’t believe that President Trump’s economic policy can derail the technological revolution that is going on on the west coast of America.”
But analysts caution that further gains for US stocks next year may not buoy the greenback.
While the dollar stabilised after the “liberation day” turbulence, analysts said Trump’s chaotic policymaking had prompted foreign investors to start hedging their exposure to the dollar when buying US stocks.
The weakness in the dollar had been driven in part by a “structural reassessment of unhedged dollar exposures by global investors, particularly in Europe”, said Deutsche Bank’s Saravelos.
Putting on the hedges, which investors do through derivative trades, exerts downward pressure on the dollar.