Soft US dollar outlook set to linger along with Fed independence worries

By Sarupya Ganguly

BENGALURU, Jan 7 (Reuters) – The outlook for the U.S. dollar among currency strategists polled by Reuters remains bearish at the start of 2026, with a modest decline expected by year-end based on persistent concerns around Federal Reserve independence and the possibility of lower interest rates. 

The greenback fell almost 10% against a basket of major currencies last year, its weakest performance since 2017. Investors weighed risks from the highest U.S. tariffs since the Great Depression, job market softness and several trillion dollars of additional U.S. borrowing planned over coming years. 

Markets have also focused on questions around the central bank’s autonomy and who will succeed Fed Chair Jerome Powell, whose term ends in May, with an announcement expected imminently. 

Over the past month there has been little to change the prevailing view among foreign exchange forecasters in a January 5-7 Reuters poll that the dollar’s downtrend will persist.

Survey medians, broadly unchanged from December, showed the euro rising about 1% per quarter, reaching $1.19 by mid-year and $1.20 by year-end. Only 17%, 12 of the 71 participants predicted it would weaken from current levels by end-2026.

“The White House wants to take control of monetary policy and set the direction of rates – and that is toward more easing,” said Vincent Reinhart, chief economist at BNY Investments and a former Fed staffer. He added that the dollar would move sideways in the near-term with little happening to monetary policy until the new chair is chosen.

“Over the medium to longer term, there are lots of reasons the dollar depreciates. The Fed eases more than other central banks, the U.S. is seen as a less attractive safe haven and the growth differential of the U.S. with the rest of the major trading partners narrows.”

The Fed has already cut the federal funds rate three times since September to a range of 3.50%-3.75%, based in large part on increased worries about a weakening job market. The U.S. central bank’s own projections show one more reduction this year.

Still, policymakers have signaled a pause to assess incoming data before easing further, underscoring divisions between officials wary of stoking inflation which is still above the 2% target and those worried about further job losses without lower rates.

Paul Mackel, global head of FX research at HSBC, said the impact from the Trump administration’s fiscal expansion “is already starting to kick in” and the effects of last year’s tariffs, which added huge costs to U.S. companies importing materials and goods from abroad, are “still materializing.”

“I don’t think we can confidently say the inflation story is done and dusted and that it’s only going to soften from here,” Mackel said. 

“But the Fed effectively still has an easing bias…so we’re in a soft dollar world that’s likely to persist in the months to come.”

Currency traders, who have maintained a net-short dollar position for much of the past year, appear set to continue their stance in the near term. 

Nearly 90% of strategists polled, 35 of 40, said net-short dollar positions would remain the same or increase by end-January.

Interest rate futures are pricing in at least two Fed rate cuts this year, with scope for further easing if policy decisions come under greater political influence.

That risk, several analysts said, was closely tied to developments around the central bank’s leadership, including the legality of President Donald Trump’s attempts to remove Fed governor Lisa Cook.

“If Trump is successful in removing Cook, there’s going to be more outflows from U.S. assets, particularly fixed income and AI,” said Erik Nelson, head of G10 FX strategy at Wells Fargo, the most accurate forecaster for major currencies in Reuters polls last year according to LSEG StarMine calculations.

“We’d also potentially see the risk of more (of the board) being removed and implicit pressure on the Fed increasing as a result,” he added, noting that would probably bring the dollar weakness trend forward and make it a more acute move.

(Other stories from the January foreign exchange poll)

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(Reporting by Sarupya Ganguly; Polling by Indradip Ghosh and Renusri K; Editing by Ross Finley, Kirsten Donovan)