USD to Ease Through 2026 as Euro, Yen Gain; Fed Eyes 1–2 Rate Cuts

The recent OMFIF outlook aligns closely with broader consensus in global FX and macroeconomic research, reinforcing the view that the dollar’s dominance may be peaking, or at least entering a phase of more modest strength. Key developments in macro data and policymaker signals provide clarity on where 2026 trajectories are headed, even though risks remain elevated.

Monetary Policy & Interest Rates
The Federal Reserve appears close to finishing—or at least materially slowing—the rate‐cutting cycle. The OECD anticipates only two rate cuts in 2026, with effective rates stabilizing in the 3.25–3.50% range. Several research firms (ING, MUFG, ABN AMRO) project that inflation, labor tightness, and fiscal pressures may limit the extent of Fed easing, keeping rate differentials only modestly narrowed. This dovish shift contributes directly to weakening USD bias, particularly if inflation remains sticky and growth supportive.

USD Outlook & Volatility
A consistent theme across multiple forecasts is a phased dollar decline: a more pronounced weakening in the first half of 2026 followed by stabilization or mild recovery later in the year. Morgan Stanley, for example, sees the DXY falling from around 100 to roughly 94 midyear before rebounding toward 100 by year‐end. ING expects structural USD weakness, reducing the probability of a sharp rebound despite episodic strength during risk‐off events.

FX Pair & Regional Dynamics
The euro stands to gain modestly, contingent on EU rate differential narrowing as ECB remains relatively cautious while Fed cuts. But Germany’s fragile outlook and fiscal constraints across key EU states may limit upside. The yen’s prospects improve if Japan follows through on modest rate normalization, narrowing yields with U.S. rates, though government debt sustainability and intervention risk remain important headwinds. For commodity and emerging‐market currencies, the outlook is mixed: CAD may gain late in 2026 with oil recovery and BoC policy, while MXN faces domestic policy constraints. Asian currencies—especially CNY/RMB—look attractive under modest nominal appreciation but strong real gains due to deflation and trade surpluses.

Strategic Implications
For institutional investors, this environment suggests prioritizing flexibility over conviction trades: hedging USD exposures, taking advantage of cross‐currency carry trades that benefit from narrowing yield gaps, and selectively allocating to European and Asian currencies with strong fundamentals. Active monitoring of Fed’s labor market data, inflation prints, and geopolitical/fiscal flashpoints (Fed Chair succession; U.S.–China tensions; trade agreement renegotiations) will be essential. If inflation spikes, growth falters, or fiscal risks intensify, a risk scenario may trigger temporary USD rallies or widen yield spreads materially.

Open Questions & Risks

• How deeply and how fast will the U.S. unemployment rate rise, and will that be enough to push the Fed into cutting more aggressively than current projections?
• Will China’s domestic demand rebound enough to reduce reliance on export‐led growth and thus pressure on the renminbi’s managed regime?
• Could policy mistakes (e.g. delayed ECB cuts, BoJ intervention, or U.S. fiscal surprises) provoke volatile reversals?
• How much will global trade policy tensions (e.g. US‐China, USMCA) or geopolitical crises feed into safe‐haven flows or disrupt FX correlations?