The U.S. dollar is likely to be on a choppy path over the next 12 months, with continued weakening in the coming months followed by a recovery and an end to the dollar’s bear market in the second half of 2026.
In its 2026 Investment Strategy Outlook, Morgan Stanley Research notes that the U.S. dollar index—a measure of the greenback’s performance against a basket of currencies of major U.S. trading partners—should fall from its current level of around 100 to 94 in the second quarter of 2026, the lowest since 2021. A rebound would bring the index back to 100 by the end of next year, with potential for further gains in 2027—a trajectory tied to economic growth, unemployment and interest rates in the U.S.
This view is an improvement over Morgan Stanley’s earlier estimation, which called for the dollar to lose as much as 10% from mid-2026 through the end of 2026. The previous forecast was based on expectations of high policy uncertainty and U.S. interest rates falling to levels near the rest of the world. However, recent developments have challenged the view of a bear regime for the dollar.
“The October Federal Reserve meeting reinforced a perception that U.S. rates are unlikely to decline as much or as quickly as previously anticipated,” says David Adams, head of G10 FX Strategy at Morgan Stanley. “A favorable global backdrop, as inflation trends lower and trade tensions abate, will also likely support the dollar.”
Bearish View in the Medium Term
Morgan Stanley’s 2026 Economic Outlook predicts U.S. growth will slow in the first half of the year before accelerating to 1.8% by year-end—up from a previous estimate of 1%. Inflation, measured by Core PCE, is expected to ease to 2.6% from 2.9% this year.
As a result, the Fed is likely continue cutting interest rates until they fall to 3%-3.25% by June, contributing to a bearish view on the U.S. dollar. Additionally, labor market uncertainty and investor focus on changes in the Fed’s Federal Open Market Committee’s composition could weigh on dollar sentiment.
For the second half of 2026, however, three factors could bolster the dollar:
- Resilient U.S. growth outlook: Optimism about U.S. growth into 2026 is rising and could reinforce a U.S. exceptionalism narrative. Fiscal stimulus from the “One Big Beautiful Bill” and the delayed effects of Fed rate cuts should sustain economic momentum.
- A rebound in U.S. rates: An end to the Fed's cutting cycle, coupled with improving growth, is likely to send U.S. rates rebounding higher, amplifying support for the dollar and curbing dollar-funded carry trades (in which investors borrow in low-rate currencies to invest in higher-yielding ones) that are unfavorable to the dollar.
- Shift in hedging behavior: Corporates and investors may turn more confident on the dollar and reduce their hedges against its depreciation.
