Last year saw the misguided attempt at a Mar-a-Lago Accord and Liberation Day in the US cause turbulence and a sharp dollar sell-off in global foreign exchange markets. But with the Federal Reserve and European Central Bank approaching or having reached the end of the rate-cutting cycle, foreign exchange trading should be far less exciting in 2026.
Predicting foreign exchange markets is a fool’s errand, but it has nonetheless sprouted a cottage industry with analysts even audaciously offering pinpoint numerical forecasts conjuring up the fallacy of false precision. Joining the fray, here are six observations on the foreign exchange outlook for 2026.
1. The dollar overall may be broadly steady to slightly down
The Fed, having already cut 175 basis points, has entered the neutral range. If US inflation proves somewhat sticky near 3%, growth holds up or performs slightly better than in 2025, as many predict, and soft labour markets continue without much higher unemployment, the Fed’s scope for rate cuts could prove limited, as the latest dot plot suggested. A new Fed chair may seek to tilt the Fed towards dovishness, but whether that commands a consensus or sows dissension will be closely watched.
Regardless, longer-term rates, especially given US fiscal excesses, will not appreciably follow any decline in short rates. President Donald Trump’s unpredictability and poor treatment of allies may further take some shine off the dollar, though market participants are more likely to continue hedging exposures rather than selling the underlying assets.
A pronounced rise in unemployment, however, could be a gamechanger, prompting more-than-expected accommodation from the Fed and driving the dollar down.
2. US/European rate differentials may narrow somewhat, supporting the euro a little
Notwithstanding forecasts for an upturn in growth, the German outlook is uncertain and fiscal support may not come on stream as quickly as expected, only hesitantly lifting protracted stagnation. Modest global growth and China competitiveness will inhibit European exports. France and Italy face fiscal constraints amid low potential growth. A further ECB cut later in the year cannot be precluded, which could also temper any euro upside.
3. The yen could rise slightly against the dollar
The Bank of Japan raised rates by 25 basis points at the end of 2025 and may do so again later in 2026. But yen demand will remain tepid to modest in response. Markets increasingly question – justifiably or not – Japan’s fiscal sustainability.
Further, the BoJ will cautiously approach any rate hiking given concerns long-term rates could jump and create frictions with the government due to worries about fiscal costs on Japan’s enormous debt. Simply put, macro policy will remain riddled with contradictions. Absent bolder BoJ hiking, if the yen stays ‘too weak’, Japan will unleash more banal open-mouth operations.
4. The Canadian dollar and Mexican peso may fluctuate narrowly against the dollar
The Canadian economy could pick up in the second half of 2026, prompting a firmer Bank of Canada stance and slightly pushing up the Loonie, notwithstanding oil prices that are likely to be tepid. Mexican macroeconomic policy flexibility remains hamstrung given fiscal restraint and inflation. Renegotiation of the US-Mexico-Canada Agreement – which makes up one-quarter of US trade – could throw a wild card into North American currency pairs.
5. The renminbi should rise modestly against the dollar, but don’t confuse nominal with real appreciation
The trade-weighted renminbi is woefully undervalued – perhaps by some 20% – reflecting China’s massive current account surpluses and deflation. Given anaemic domestic demand and an unwillingness to proactively use fiscal policy to support consumption, China is relying on a weak renminbi to buttress exports, even though doing so doubles down on its distortionary state-led investment growth model and exacerbates global protectionism.
Further, with China facing no inflation, a stable nominal renminbi results in added real appreciation. The renminbi is a managed currency, though facing challenges due to capital outflow. Given these conflicting forces, China will allow modest nominal renminbi appreciation, but preserve its strong real competitiveness.
6. The US may put exchange rates back on the international agenda
Despite Trump’s focus on reducing the US trade deficit and resuscitating manufacturing, US deficits will remain high and little changed while the longstanding secular decline in manufacturing is not budging. The administration has not yet zeroed in on exchange rates given Trump 2.0’s trade focus and recent efforts to de-escalate trade tensions with China.
But with huge entrenched Chinese surpluses – even if down bilaterally with the US – continuing transshipments, Europe waking up to renminbi weakness and French President Emmanuel Macron emphasising G7 talks on global imbalance, rifts over renminbi undervaluation may return. Similarly, despite Japan’s trade deficits, the massive current account surplus and the highly undervalued yen could generate controversy. US Treasury Secretary Scott Bessent has criticised yen weakness. Perhaps the Treasury’s Foreign Exchange Reports will find some bite, or Trump 2.0 might wrongheadedly return to currency undervaluation trade cases.
Of course, the administration will find it easier to blame others for large US trade deficits than acknowledge the strong contribution made from America’s longstanding fiscal recklessness. Nonetheless, rhetoric aside, expect more calm on major FX markets in 2026. Perhaps hedge funds will have to work hard to beat the market average, let alone earn their 2/20.
Mark Sobel is US Chair of OMFIF.
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