Will the Dollar Fall in 2026? Morgan Stanley's Currency Forecast Points to Weakness Ahead

The Dollar’s Declining Path in 2026

Morgan Stanley projects a challenging year for the U.S. Dollar Index (DXY), predicting a notable 5% decline to approximately 94 by mid-2026. This forecast signals that the dollar’s recent strength may be temporary, with significant volatility expected throughout the year. The prediction hinges on the Federal Reserve’s anticipated monetary policy trajectory and labor market dynamics.

Why Will the Dollar Fall: The Fed Rate-Cutting Factor

The primary driver behind this bearish outlook is the Federal Reserve’s expected rate-cutting cycle. Morgan Stanley strategists anticipate three additional rate cuts from the Fed by the end of the first half of 2026, amid a softening labor market. As U.S. interest rates converge downward toward international levels, the dollar loses its attractiveness as a carry currency. The Fed’s “proactive dovishness”—maintaining accommodative policy despite seasonal CPI fluctuations—will likely extend the dollar’s weakness deep into 2026’s first half.

Currency Dynamics: The Cross-Trade Shift

The narrative changes significantly in the latter half of 2026. As the Federal Reserve concludes its cutting cycle and U.S. economic growth accelerates, Morgan Stanley forecasts a shift into what it calls a “carry regime.” This transition will reshape currency market dynamics fundamentally. U.S. real rates are expected to rebound, but this creates an intriguing paradox for dollar traders.

Alternative Funding Currencies Gain Ground

When the bear phase dominates the first half, traditional funding currencies like the Swiss franc (CHF), Japanese yen (JPY), and euro (EUR) offer lower carry costs compared to the dollar. However, Morgan Stanley emphasizes that in the second half, as risk appetite strengthens, European currencies—particularly the Swiss franc—are positioned to outperform. The selection of funding currency becomes crucial for optimizing cross-currency trades and managing carry trade economics.

Practical Implications for Traders

Understanding this dual-phase outlook is essential for currency strategy. In early 2026, dollar weakness creates opportunities for those shorting the USD or favoring European exposure. The transition to a carry regime later in the year will reward positions that factor in the evolving interest rate differential and currency appreciation potential of alternatives to the U.S. dollar.