Major Wall Street banks are intensifying predictions that the US dollar will weaken substantially over the next year, driven by anticipated Federal Reserve interest rate cuts, slowing economic growth, and uncertainty surrounding President Donald Trump's trade and tax policies. Morgan Stanley forecasts the greenback will drop approximately 9% to levels not seen since the Covid-19 pandemic by mid-2026, while other major financial institutions echo similar bearish sentiment.
What to Know:
- Morgan Stanley predicts the US Dollar Index will fall 9% to 91 by next year amid multiple economic headwinds
- JPMorgan and Goldman Sachs join the bearish outlook, citing trade tensions and potential tax policy changes
- The dollar has already declined against all major currencies, with factory activity contracting for three consecutive months
Currency Markets React to Policy Uncertainty
The dollar's decline accelerated Monday as global trade tensions flared. Factory activity data showed US manufacturing contracted for the third straight month in May. The Bloomberg Dollar Spot Index fell 0.6% to approach its weakest intraday level since 2023.
Currency positioning data reveals short positions on the dollar remain near their highest levels since 2023, though strategists note bearishness hasn't reached extreme levels. This suggests additional downward pressure could emerge. "We think a medium-term narrative around a weaker dollar is building," said Aroop Chatterjee, a strategist at Wells Fargo in New York.
International investors are reassessing their US asset exposure amid policy uncertainty. Matthew Hornbach, global head of macro strategy at Morgan Stanley, explained that foreign investors are increasing hedging ratios on their dollar positions. This defensive positioning will likely contribute to downward pressure on the currency over the next 12 months.
Federal Reserve Policy Drives Expectations
Morgan Stanley's analysis centers on expected Federal Reserve policy shifts. The bank projects the 10-year US Treasury yield will reach 4% by year-end before declining sharply in 2026. They anticipate the Fed will deliver 175 basis points of interest rate cuts as economic conditions deteriorate.
JPMorgan strategists led by Meera Chandan reinforced their negative dollar outlook last week. Instead, they recommend positioning in the Japanese yen, euro, and Australian dollar. These currencies are expected to benefit from the dollar's weakness as global investors seek alternatives.
The euro has already responded to shifting sentiment. It climbed to a five-week high of $1.1450 on Monday. Morgan Stanley sees the euro potentially reaching $1.25 next year as European assets become more attractive relative to US investments.
Alternative Currencies Gain Ground
Currency strategists identify several beneficiaries of dollar weakness. The British pound may advance from approximately $1.35 to $1.45, supported by higher interest rate differentials and lower trade tension risks compared to the US. The Japanese yen, which jumped 1% Monday to trade at 142.54 per dollar, could strengthen to 130 according to Morgan Stanley analysts.
The Australian dollar also gained 1% as commodities and emerging market currencies benefit from reduced dollar strength. Swiss franc positions are similarly favored as investors seek safe-haven alternatives to dollar-denominated assets.
Skylar Montgomery Koning, a currency strategist at Barclays, noted that "headwinds for the dollar could come in the form of further bond market weakness, an escalation in the trade war, softer US data." These factors are converging to create sustained pressure on the greenback.
Tax Policy Concerns Mount
Goldman Sachs analysts highlight additional risks from potential US tax policy changes. Buried within Trump's tax-and-spending legislation are provisions for higher taxes on passive income earned by foreign investors. These measures target interest and dividends from American assets potentially worth trillions of dollars.
The tax provisions, while narrow in application, could accelerate foreign investor concerns about US asset risks. Goldman Sachs strategists Kamakshya Trivedi and Michael Cahill warned that such measures "would exacerbate concerns about risks of US investments, at a time when investors are already looking at shifting cross-asset correlations as a reason to seek greater diversification away from US assets."
Separate Goldman Sachs models suggest the dollar is approximately 15% overvalued, indicating substantial room for further decline. The bank expects this correction will be driven by global asset reallocation and repricing as investors reduce US exposure.
Economic Data Influences Outlook
Labor market indicators scheduled for release this week, including the May employment report, will provide crucial insight into Federal Reserve policy direction. Investors are closely monitoring these metrics for signals about future interest rate decisions and their implications for dollar strength.
Trade negotiations between China and the US add another layer of uncertainty. Both nations have accused each other of violating agreements reached last month. Any escalation in trade tensions could accelerate dollar weakness as global investors seek alternatives to US markets.
Paresh Upadhyaya at Pioneer Investments expects the Bloomberg dollar gauge to depreciate 10% during the next 12 months. He cites "diminishing US growth exceptionalism, uneven policy implementation by the US administration, persistent portfolio outflows" as key factors pressuring the currency.
Closing Thoughts
Wall Street's major banks have reached consensus that the dollar faces significant headwinds over the next year, with Morgan Stanley's 9% decline forecast representing the most specific prediction. The combination of expected Federal Reserve rate cuts, trade policy uncertainty, and potential tax changes on foreign investment creates multiple pressure points for the world's reserve currency. Currency markets are already reflecting these concerns, with positioning data and price action suggesting the dollar's weakness may continue well into 2026.