Morgan Stanley Forecasts USD Weakness Through Mid-2026: Strategic Implications for Currency Traders

The Dollar’s Predicted Path: A Two-Phase Scenario

Morgan Stanley’s latest currency outlook paints a complicated picture for USD traders in 2026. The investment bank projects the U.S. Dollar Index (DXY) will decline approximately 5% to reach 94 by mid-year, signaling a continuation of the bearish dollar environment that’s dominated recent markets. However, this weakness is not expected to last the entire year—a potential rebound could emerge as 2026 progresses.

This bifurcated forecast reflects two distinct market regimes. In the first half, the “USD bear phase” will likely persist, underpinned by aggressive Fed monetary easing and labor market softening. Morgan Stanley’s strategists anticipate at least three additional Federal Reserve rate cuts between now and mid-2026, keeping US interest rates under downward pressure relative to international peers.

Why the Dollar Stumbles in H1 2026

The primary catalyst for USD weakness traces directly to Fed policy. The central bank’s proactive rate-cutting stance—maintained even as inflation shows seasonal volatility—will continue narrowing the interest rate differential between US and foreign assets. When US real yields decline faster than overseas alternatives, the dollar typically loses its appeal.

A deteriorating labor market compounds this dynamic. As employment growth slows, Fed officials face political pressure to prioritize growth over inflation vigilance, effectively prolonging the cutting cycle beyond what fundamentals might otherwise justify.

The Mid-Year Inflection: When Carry Trades Take Center Stage

The narrative shifts substantially in H2 2026. Morgan Stanley forecasts that as the Fed concludes its cutting cycle and US economic growth reaccelerates, US real interest rates will stabilize or even rise. This marks the transition into a “carry regime”—a period where currency markets reward investors for funding their trades in lower-yielding currencies to purchase higher-yielding assets.

In this environment, traditional funding currencies gain appeal. The Swiss franc (CHF), Japanese yen (JPY), and euro (EUR) are positioned to strengthen as investors unwind carry trades. Simultaneously, higher-yielding or risk-sensitive currencies—including NZD—could attract capital seeking better returns. The USD itself may struggle as a funding currency despite its relative yield advantage over CHF and JPY, due to its reduced interest-rate superiority in this new regime.

Strategic Considerations for Currency Traders

The transition between these two phases creates both risks and opportunities. Traders holding long USD positions during H1 2026 face headwinds, with a 5% decline representing meaningful slippage. However, premature profit-taking before the mid-year inflection point could prove costly if the rebound materializes faster than expected.

European currencies, particularly CHF, emerge as Morgan Stanley’s preferred trade for H2 2026. These assets are expected to benefit disproportionately as the Fed’s restrictive cycle winds down and cross-currency correlations shift. For those considering USD/NZD positions, the first half may present challenges, though the dynamic could improve in the second half depending on New Zealand’s own monetary policy trajectory.

The key takeaway: 2026 will require active strategy rotation. Static positions betting on either perpetual USD weakness or strength risk being caught between two conflicting market regimes.