What Lies Ahead for the Dollar in 2026? Morgan Stanley Maps Out Currency Volatility's Letter

The U.S. dollar faces a turbulent year ahead, according to Morgan Stanley’s latest currency outlook. The investment bank projects the Dollar Index (DXY) to shed roughly 5% and touch 94 by the middle of 2026—a significant move that marks a fundamental shift in how traders should position themselves across global markets.

The First Half Story: Dollar Weakness Amid Fed Cuts

Morgan Stanley’s strategists paint a clear picture for the first six months of 2026: sustained dollar weakness. The reasoning is straightforward—the Federal Reserve is expected to deliver three additional interest rate cuts through mid-2026 as labor market conditions soften. This monetary loosening creates what traders call a “USD bear regime,” where the greenback loses appeal as U.S. yields converge downward with international counterparts.

The letter of volatility we’re witnessing isn’t random. It’s driven by a deliberate monetary policy pivot. Even as inflation metrics show seasonal fluctuations in consumer prices, the Fed’s “proactive dovish” stance will likely maintain downward pressure on the dollar. For currency traders, this translates into a straightforward thesis: don’t fight the Fed when it’s cutting.

The Pivot Point: Mid-Year Transition

Here’s where Morgan Stanley’s outlook gets interesting. As we cross into the second half of 2026, the dynamics fundamentally change. The Fed completes its rate-cutting cycle just as U.S. economic growth begins accelerating. This twin shift triggers what strategists call a “carry regime”—a market environment where investors pursue returns by borrowing cheap currencies to fund investments in higher-yielding assets.

In this new regime, real U.S. interest rates are projected to rebound, affecting the strategic calculus across currency pairs. The dollar’s role shifts from a straightforward weak performer to something more nuanced—a funding currency with elevated carry costs.

The Winner’s Circle: European Currencies Ascend

While the dollar struggles in the first half, European currencies emerge as the clear beneficiaries. The Swiss franc (CHF), euro (EUR), and Japanese yen (JPY) are positioned to outperform as the carry regime takes hold. Among these, Morgan Stanley singles out the Swiss franc as particularly attractive for traders looking to establish carry trades in the latter half of 2026.

The rationale is compelling: traditional funding currencies like CHF and JPY offer lower yields, but their stability and appreciation potential in a shifting rate environment make them valuable for sophisticated trading strategies. As the year progresses, returns increasingly favor those holding European currency exposure.

Strategic Takeaway for 2026

Morgan Stanley’s analysis suggests that 2026 will require tactical flexibility. Traders who profit from dollar weakness in the first half must be prepared to pivot their positioning as the carry regime develops. The choice of funding currency becomes critical—what works early in the year may become a liability by December. Understanding this letter of volatility isn’t just academic; it’s the difference between capitalizing on currency trends and being caught off-guard by regime shifts.