U.S. Dollar Rebound Amid Rising Inflationary Pressures: Strategic Positioning for a Long-Term Bull Case

The U.S. dollar, a cornerstone of global finance, faces a pivotal juncture as inflationary pressures and shifting monetary policies reshape its trajectory. While the greenback has experienced a notable decline in 2025-falling 10% against the euro and depreciating modestly against Asian currencies-structural forces and evolving policy dynamics suggest a compelling long-term bull case for the dollar. This analysis explores how the interplay of inflation differentials, Federal Reserve policy, and global monetary realignments could catalyze a sustained rebound in the U.S. currency.

Inflationary Divergence and the Dollar's Relative Strength

The U.S. inflation slowdown to 2.7% year-on-year in November 2025, though tempered by data collection challenges during the government shutdown, underscores a critical divergence from global trends. While the eurozone and the U.K. are projected to stabilize near their 2% inflation targets, the U.S. faces lingering inflationary pressures from tariffs and trade policy spillovers. J.P. Morgan analysts note that core PCE inflation could peak at 4.6% in Q3 2025 before gradually easing, driven by delayed tariff impacts on consumer prices. This divergence creates a unique backdrop: the U.S. dollar may benefit from a relative "safe haven" status as global inflation stabilizes, while its domestic counterpart remains elevated but contained.

Emerging markets further highlight this divergence. Asian economies, plagued by weak demand and industrial overcapacity, exhibit subdued inflation, whereas Latin America and sub-Saharan Africa grapple with structural inflationary challenges. Such regional asymmetry could drive capital flows toward the dollar, particularly as U.S. wage growth remains anchored, mitigating the risk of a wage-price spiral.

Federal Reserve Policy: A Dual-Edged Sword

The Federal Reserve's policy trajectory is central to the dollar's long-term prospects. In December 2025, the Fed cut rates by 25 basis points, bringing the federal funds rate to 3.50-3.75%, amid a cooling labor market and moderating inflation expectations. While rate cuts typically weaken the dollar by reducing yield differentials, the Fed's cautious approach-projected to deliver one or two additional cuts in 2026-may stabilize the currency. Goldman Sachs Research anticipates a terminal rate of 3-3.25% by mid-2026, with policy normalization expected to narrow the U.S. interest rate gap with Europe and Asia.

Crucially, the Fed's balance sheet management, including Treasury bill purchases to maintain liquidity, could bolster the dollar's resilience. As stated by New York Fed President John Williams, inflation is expected to moderate to 2.5% in 2026 and 2% in 2027, suggesting a measured policy path that avoids abrupt rate hikes. This stability could attract investors seeking refuge from the volatility of emerging markets and the eurozone's uncertain fiscal landscape.

Structural Shifts in Global Monetary Dynamics

The dollar's long-term strength hinges on broader structural shifts. RBC Wealth Management highlights that the U.S. currency has entered a bearish phase since early 2022, driven by overvaluation and global diversification away from U.S. assets. However, this bear market may present a contrarian opportunity. Morgan Stanley projects the DXY could fall to 94 in Q2 2026 before rebounding to 100 by year-end, fueled by U.S. growth outpacing global peers and a narrowing inflation gap.

Global central banks' divergent policies further tilt the dollar's favor. The European Central Bank's hawkish stance and the Bank of England's aggressive easing contrast with the Fed's cautious normalization, creating a fertile environment for dollar appreciation. Meanwhile, Japan's modest tightening and China's targeted easing underscore the U.S.'s relative policy flexibility, enhancing the dollar's appeal as a reserve currency.

Strategic Positioning for Investors

For investors, the long-term bull case for the dollar rests on three pillars:
1. Inflation Differentials: As U.S. inflation stabilizes near 2.6% (core CPI) by 2027, the dollar's relative strength against high-inflation emerging markets will likely widen.
2. Policy Normalization: The Fed's measured rate cuts and liquidity management will support a gradual dollar rebound, particularly if global growth disappoints.
3. Structural Resilience: The dollar's role as a global reserve currency, coupled with its dominance in trade and debt markets, ensures enduring demand despite short-term volatility.

Investors should consider dollar-pegged assets, U.S. Treasuries, and equities with strong dollar exposure. Conversely, hedging against short-term dollar weakness via diversified portfolios-incorporating high-yield municipal bonds and structured credit-can mitigate risks while capitalizing on the eventual rebound.

Conclusion

The U.S. dollar's path in 2026 is marked by both headwinds and tailwinds. While near-term depreciation reflects policy uncertainty and global reallocation of capital, structural factors-including inflation differentials, Fed normalization, and the dollar's reserve status-position it for a sustained rebound. Investors who recognize this asymmetry may find the current volatility an opportunity to strategically position for a long-term bull case, anchored in the dollar's enduring role as the world's preeminent currency.