Currency Forecasts Show Dollar Weakens in H1 2026, Then Recovers: What Morgan Stanley Sees Ahead

Morgan Stanley’s latest currency outlook reveals a striking divergence in dollar trends across 2026. The strategists project the U.S. Dollar Index (DXY) will decline roughly 5% to the 94 level by mid-year, marking a continuation of the prevailing “USD bear regime.” This weakness stems from an expected three rate cuts from the Federal Reserve through the first half of 2026, as policymakers respond to labor market softening and inflation dynamics. The central bank’s accommodative stance—cutting rates even amid seasonal CPI fluctuations—will keep downside pressure on the currency throughout the first six months.

The Pivot Point: When Dollar Weakens Gives Way to Recovery

The second half of 2026 presents an entirely different picture. As the Fed winds down its cutting cycle and U.S. economic growth accelerates, Morgan Stanley anticipates a meaningful rebound in dollar strength. The transition hinges on rising real rates and a shift from simple currency depreciation to what analysts term a “carry regime”—essentially a period where cross-currency trading dynamics dominate market movements. This structural change will fundamentally alter which currencies attract capital flows and hedge positioning.

Strategic Implications for Currency Pairs

During the bear phase when the dollar weakens through mid-2026, the greenback paradoxically becomes attractive as a funding currency for carry trades, despite elevated carry costs relative to alternatives like the Swiss franc (CHF), euro (EUR), and Japanese yen (JPY). However, the playbook flips dramatically in H2 2026. Morgan Stanley expects European currencies—particularly CHF—to emerge as superior funding choices once the carry regime takes hold. Risk currencies will likely outperform while funding currencies depreciate, positioning tactical traders to favor the aforementioned alternatives over the dollar.

The key takeaway: 2026 represents a year of two distinct trading regimes, requiring investors to adjust currency hedging and positioning strategies at the mid-year inflection point.