Key themes for the US dollar and global FX markets.
The US dollar initially rallied from 97.9 in late-December to 99.4 mid-January. However, it then lost its way, falling back to a near 4-year low of 96.2, now 97.0. At the current level, the US dollar is around 15% below its mid-2022 peak and circa 1.5% under its 10-year average. Our baseline expectation is that the dollar will settle between its current level and the 20-year average over the coming 12-18 months, but risks are arguably skewed to the downside.
It is not as though we have a pessimistic view on the US economy, however. Indeed, quite the opposite. As detailed on page 16 of the February Market Outlook (linked below), our baseline expectation for 2026 is another year of above-trend growth, led by the consumer and tech infrastructure investment. Underlying this expectation is the view that the labour market will remain fully employed and wage growth ahead of inflation.
Along with the lagged effect of tariffs and evidence of capacity constraints across a number of key sectors such as housing, transport, energy and health, there is therefore good reason to believe that inflation will remain above the FOMC’s 2.0%yr target and risks skewed to the upside. The above views on growth and inflation are why we hold the expectation of one more cut from the FOMC loosely against market pricing for at least two cuts this year.
Why then do we expect the US dollar to fall further and risks to remain skewed to the downside? It is because of the opportunities elsewhere.
Regarding financial opportunities, the strong run for US equities limits the chance of further outperformance, the global dominance of US technology firms notwithstanding. Also, unlike the years immediately following the pandemic, the narratives around both Europe and Asia’s economies are increasingly focused on growth and economic development rather than trade risks, and investors have been taking note of these themes.
As important as the trends themselves are their likely persistence, with economic growth in Europe and Asia to continue receiving support over the coming decade and potentially beyond. This is a striking contrast to the US’ current situation where the upcycle in infrastructure spending is likely at or very near its peak, and the dividend from it likely to come in the form of distributed efficiency wins across the economy and for profits, more so than an outright surge in production and national income.
Considering recent developments by each bilateral exchange rate within the DXY group, euro and sterling have clearly been the big winners. Since mid-January, EUR/USD has risen from USD1.16 to USD1.19, which is materially above the average of the past decade, USD1.12. Sterling has followed suit, GBP/USD rising from USD1.30 in November (also its decade average) to USD1.36 today.
The Canadian dollar’s recent gain has been more modest, USD/CAD only falling from CAD1.39 in mid-January to CAD1.36, above the decade average of CAD1.33 (i.e. the Canadian dollar is still below its 10-year average versus the US dollar). Meanwhile, Japan’s yen has been little changed on net since mid-December, albeit with considerable volatility day-to-day amid a myriad of political and geopolitical developments.
Ahead, amongst the DXY pairs, relative changes are likely to follow a similar pattern, with euro and sterling most likely to show strength – we believe to respective peaks of USD1.22 and USD1.41 by mid-2027. The Canadian dollar is also expected to rally materially, but likely not until late-2027 and 2028 once growth has strengthened and trade uncertainties have been put to rest. At June 2027, we expect USD/CAD to only be marginally lower at CAD1.34. But by June 2028, we forecast USD/CAD to have fallen to CAD1.30. For each currency, there is clear upside against the US dollar, but likely only if downside US economic and / or policy risks assert.
A similar logic can be laid out for the yen. Prime Minister Sanae Takaichi and the LDP’s historic win in February’s lower house election will provide considerable scope for fiscal policy to aid growth and confidence amongst businesses and consumers – the latter group particularly if the suspension of the consumer tax on food goes ahead. Still, the stance of monetary policy is unlikely to change materially in the near term, and so yield support for the yen should hold at current levels, not increase. Yen appreciation is therefore only seen gaining momentum as growth sustains and persistent inflation gives the Bank of Japan cause to act. Global investment flows are also important for the yen’s outlook. We continue to look for USD/JPY to slowly track down to JPY145 at end-2026, then JPY139 come mid-2028, still well above 2019’s JPY109 level.
While not a constituent of the DXY index, China’s renminbi is evidence of participants growing belief in Asia. From a peak of CNY7.35 last April, USD/CNY has declined to CNY6.90 at present, a 6% appreciation for the renminbi. Ahead, we expect a similar sized appreciation against the US dollar, albeit spread across the next 18 months to CNY6.35 at mid-2028. If China’s Central Government can reset the domestic economy decisively, then additional strength could be seen over a short period. The investment China has undertaken across Asia and its underlying development prospects are likely to see gains in the renminbi spread to other regional currencies over time.
This analysis first appeared in Westpac Economics’ February Market Outlook which also includes our latest forecasts for Australia and the global economy.
