Sinking dollar has further to go as Fed to cut much more than expected: MS

Morgan Stanley forecasts a 9% decline in the U.S. dollar (DXY) by mid-2026, driven by expectations of aggressive Federal Reserve rate cuts totaling 175 basis points in response to weaker U.S. growth and moderating inflation. The firm anticipates U.S. real GDP growth slowing to 1.0% in both 2025 and 2026, with 10-year Treasury yields falling to just above 3.00% by the end of 2026, leading to outperformance versus German Bunds, UK gilts, and JGBs. Morgan Stanley projects EUR/USD to rise to 1.25 and GBP/USD to 1.45 by mid-2026.

Analysis

Morgan Stanley has intensified its bearish outlook on the U.S. dollar, forecasting an additional 9% decline in the DXY to 91 over the next 12 months, after its previous year-end target of 101 was reached prematurely. This revised projection is underpinned by expectations for more aggressive Federal Reserve rate cuts, totaling 175 basis points after most of 2025, significantly exceeding current market pricing, in response to anticipated weaker U.S. real GDP growth—projected to slow from 2.5% in 2024 to 1.0% in both 2025 and 2026—and inflation returning to target. The bank attributes the U.S. growth slowdown to factors including tariffs, immigration restrictions, and a lack of significant fiscal policy support. Consequently, 10-year U.S. Treasury yields are forecast to decline to just above 3.00% by the end of 2026, potentially outperforming German Bunds, UK gilts, and JGBs. This environment is expected to drive EUR/USD to 1.25 and GBP/USD to 1.45 by mid-2026. Despite moderating global inflation, U.S. core PCE inflation is anticipated to remain above the Federal Reserve's target through 2026, influenced by persistent price pressures from tariffs.

Key Decisions for Investors

• Investors should evaluate strategies for hedging U.S. dollar exposure or positioning for its depreciation, given Morgan Stanley's significantly bearish forecast.
• Consider potential for outperformance in U.S. Treasuries, particularly longer-dated issues, as the forecast for deeper Fed cuts and lower yields diverges from current market expectations.
• Monitor upcoming U.S. economic indicators, specifically GDP growth and inflation data, alongside Federal Reserve communications, to assess the likelihood of the projected aggressive easing cycle.
• Re-evaluate currency allocations, as the analysis suggests potential for material appreciation in EUR and GBP against the USD by mid-2026.