The U.S. Dollar in 2026: Repricing Risk, Reshaping Returns

The U.S. dollar, long the cornerstone of global finance, faces a pivotal juncture in 2026. Structural shifts in economic fundamentals, evolving central bank strategies, and shifting investor sentiment are converging to redefine the dollar's role in a multipolar world. As global markets grapple with the implications of U.S. fiscal policy, geopolitical tensions, and the rise of alternative currencies, strategic currency positioning has become a critical consideration for institutional investors and central banks alike.

Structural Shifts Undermining Dollar Dominance

The dollar's structural challenges in 2026 are rooted in a confluence of macroeconomic and geopolitical factors. J.P. Morgan Global Research highlights that U.S. growth moderation, broad-based tariffs, and widening fiscal deficits are eroding the dollar's traditional appeal. By late 2025, the dollar index (DXY) had fallen to 98.6, reflecting a 10% decline from earlier in the year-the worst start since the 1970s. This depreciation is compounded by the dollar's overvaluation, driven by persistent trade deficits and higher inflation relative to other developed markets.

Meanwhile, the euro is poised to benefit from U.S. economic softness and German fiscal stimulus, with EUR/USD projected to reach 1.22 by mid-2026. The European Central Bank's (ECB) pause in its easing cycle further amplifies the euro's relative strength, creating a divergence in monetary policy trajectories that pressures the dollar.

Investor Sentiment and Currency Positioning

Global investor sentiment toward the dollar has turned cautious, with institutional investors recalibrating portfolios to hedge against volatility. Morgan Stanley forecasts that the DXY could dip to 94 in Q2 2026, driven by the Federal Reserve's rate-cutting cycle and labor market uncertainty. However, a potential rebound to 100 by year-end remains contingent on resilient U.S. growth and easing trade tensions.

Abn Amro Research underscores the dollar's vulnerability to narrowing rate differentials and fiscal imbalances, predicting further weakness in 2026. This has prompted a shift in hedging behavior, with investors increasingly favoring non-U.S. equities and diversified currency exposure. As noted by RBC Global Asset Management, non-U.S. equities outperformed in dollar terms during the first half of 2025, a trend likely to continue if the dollar enters a secular weakening phase.

Central Bank Divergence and Reserve Currency Dynamics

Despite the dollar's short-term struggles, its structural dominance persists. Central banks still hold 56.3% of global reserves in U.S. dollars, and the currency remains involved in nearly 90% of global FX transactions. According to TastyFX, the dollar's resilience is also tied to its role as the primary vehicle for global trade and U.S. Treasury demand. Yet, structural headwinds-including demographic shifts (e.g., falling immigration and rising retirements) and policy unpredictability-pose long-term risks. As RBC Wealth Management notes, the dollar's path will likely be non-linear, with periodic rallies driven by relative growth and rate differentials.

Strategic Implications for Investors

For institutional investors, the 2026 outlook demands a nuanced approach to currency positioning. As advised by Nuveen, diversification across asset classes and geographies is critical to mitigating dollar volatility. Currency hedging strategies, particularly in U.S. equity holdings, are gaining traction as global investors seek to protect returns from exchange rate fluctuations.

Central banks, meanwhile, face a delicate balancing act. While the dollar's reserve status provides a buffer against fundamental weaknesses, prolonged fiscal deficits and geopolitical risks could erode confidence. A shift toward multi-currency reserves and regional trade settlements may further accelerate the dollar's relative decline.

Conclusion

The U.S. dollar in 2026 is at a crossroads. Structural shifts in economic policy, geopolitical dynamics, and investor behavior are reshaping its trajectory. While the dollar's foundational role in global finance remains intact, its dominance is increasingly contested. For investors, the key lies in proactive positioning-leveraging cyclical volatility while hedging against long-term structural risks. As the year unfolds, the interplay between U.S. growth resilience and global diversification trends will determine whether the dollar regains its footing or cedes ground to a more multipolar currency landscape.