Morgan Stanley Forecasts Dollar Weakens Throughout 2026: A Tale of Two Halves in Currency Markets

Morgan Stanley’s latest currency analysis paints a complex picture for the coming year, with the U.S. dollar facing a period of sustained pressure before potential recovery. According to the investment bank’s strategists, funding currency dynamics will undergo a dramatic transformation, with traditional safe-haven assets like the Swiss franc (CHF), euro (EUR), and Japanese yen (JPY) reshuffling their positions across two distinct market regimes.

The First Half: Dollar Weakens Amid Fed Easing

The initial phase of 2026 is expected to see the U.S. Dollar Index (DXY) slide approximately 5% to reach the 94 level by mid-year. This depreciation stems from the broader “USD bear regime” that Morgan Stanley anticipates will persist through the first half of the year. The primary catalyst behind this weakness lies in the Federal Reserve’s expected policy trajectory—three additional rate cuts are projected before the halfway point of 2026, reflecting a shift toward accommodative monetary policy amid labor market softening.

The mechanism driving dollar depreciation is straightforward: as U.S. interest rates converge downward toward international levels, the appeal of dollar-denominated assets diminishes. The Fed’s continued dovish positioning, even as inflation trends remain influenced by seasonal factors, is likely to sustain downward pressure on the dollar for an extended timeline. During this bear phase, the dollar paradoxically maintains its utility as a funding currency despite elevated carry costs, retaining appeal primarily due to its stability and liquidity characteristics.

The Turning Point: Structural Shift in H2 2026

Morgan Stanley projects a meaningful inflection as 2026 progresses into the second half. The Fed’s rate-cutting cycle is expected to conclude, coinciding with strengthening U.S. economic growth momentum. This conjuncture sets the stage for a rebound in real U.S. interest rates, fundamentally altering the currency market landscape. Rather than a simple dollar recovery, Morgan Stanley envisions a transition into a “carry regime”—a market environment where cross-currency trades and relative yield differentials dominate trading flows.

Under this emerging regime, risk currencies gain traction as investors pursue higher returns, while funding currencies face systematic weakness. Paradoxically, the dollar itself slides into a vulnerable position as a funding currency, despite its historical safe-haven status. This realignment creates opportunities across currency pairs, particularly favoring European counterparts.

The European Advantage: CHF Emerges as Preferred Funding Choice

As the carry regime develops, Morgan Stanley identifies European currencies—most notably the Swiss franc—as positioned to outperform in the latter half of 2026. The CHF is expected to evolve into the preferred funding currency choice, displacing the dollar from its traditional role. The euro and Japanese yen similarly benefit from this structural rotation, though the franc’s relative strength in a carry environment makes it particularly attractive for sophisticated traders and institutional investors seeking cost-efficient funding options.

This shift represents more than a temporary fluctuation; it signals a deeper reordering of how market participants source funding for leveraged positions. Traditional funding alternatives like the yen and franc, combined with robust European growth expectations, position these currencies as more efficient choices compared to dollar-based carry trades in the second half of the year.

Strategic Implications for Currency Traders

Morgan Stanley’s dual-regime forecast underscores the importance of tactical positioning throughout 2026. Market participants should recognize the dollar weakens in predictable phases rather than experiencing a monotonic decline. The transition from bear regime to carry regime reshapes not just currency valuations, but the entire risk-return calculus for international capital flows. Success in this environment demands flexibility—strategies optimized for the first half’s dollar weakness may prove suboptimal once the carry regime takes hold in the second half.