Dollar Rally Faces 2026 Turning Point as Morgan Stanley Predicts Sharp Mid-Year Slump

Morgan Stanley expects the U.S. dollar’s strong run to lose momentum in 2026, forecasting a volatile year marked by a sharp decline in the first half before a late-year rebound. According to the bank’s strategists, the DXY index could fall roughly 5% to around 94 by mid-2026 as the “USD bear regime” that has dominated much of this year continues into the first half of next year.

The anticipated weakness is driven largely by expectations that U.S. interest rates will continue to compress relative to global peers. Morgan Stanley projects three additional Federal Reserve rate cuts by the end of the first half of 2026, alongside declining terminal rate expectations as the labor market softens. This combination, paired with what they describe as the Fed’s “proactive dovishness despite residual seasonality in CPI,” is expected to keep broad-based dollar weakness in place.

However, the outlook shifts in the second half of 2026. As the Fed wraps up its cutting cycle and U.S. economic growth stabilizes, Morgan Stanley anticipates a rebound in U.S. real yields for “risk-positive reasons.” This transition is expected to usher in a carry-trade environment where risk-sensitive currencies gain strength, traditional funding currencies weaken, and the dollar finds itself navigating a more balanced landscape.

During the early-year dollar downturn, the bank sees the greenback remaining a preferred funding currency, even with its higher carry cost compared to the Swiss franc, Japanese yen, and euro. But once the carry regime accelerates later in the year, the funding advantage shifts. Morgan Stanley highlights European currencies—particularly the Swiss franc—as the most attractive funders for generating total returns.

The bank’s outlook suggests that 2026 will be defined not just by directional dollar moves, but by strategic cross-currency opportunities as investors reassess funding choices in a shifting global rate environment.