Published: December 17th, 2025
For most of the past decade, USD benefited from higher interest rates, robust growth, and a sense of American economic exceptionalism. Now support is thinning as the world's global reserve currency looks set to weaken into early 2026.
Invesco's latest annual outlook argues that the Greenback's yield advantage is fading as central banks diverge in unexpected ways. The Federal Reserve, once the most resolutely hawkish of the rich world's monetary authorities, is edging towards easier policy. Others like Japan are tentatively moving the other way.
The result, says Invesco, is a currency caught on a downward slope.
Monetary policy is the current source of Dollar weakness. Invesco analysts say the Federal Reserve could cut interest rates three or four times in 2026 if America's labour market continues to soften. The Fed has already lowered rates and made little effort to push back against market expectations of further easing. Fed Chaiman Jerome Powell has signalled unease about employment conditions, implying that inflation no longer monopolises policymakers' attention.
By conceding that risks to the labour market are rising, the Fed is reinforcing the view that rates will drift lower rather than snap back higher. Elsewhere, the picture looks different. Invesco singles out the Bank of Japan as the one major central bank likely to raise rates before the end of 2026.
After decades of monetary torpor, Japan's policymakers are gingerly tightening policy as wages rise and inflation proves less ephemeral than once feared. Even modest increases in Japanese rates narrow the yawning gap that once made the yen a favourite funding currency for carry trades against the dollar.
Invesco argues that narrowing spreads will sap demand for short-term American assets and reduce the incentive to hold dollars purely for yield. The firm also notes that the currency remains overvalued on a trade-weighted basis, still above its long-term real equilibrium. That leaves plenty of room for depreciation once the tide turns.
Invesco also points to the mechanics of global capital flows as another headwind, particularly currency hedging. As interest-rate gaps narrow, the cost of hedging dollar exposure for foreign investors falls. That encourages greater hedging activity, which in turn generates additional selling pressure on the dollar. What was once a technical footnote becomes a meaningful drag when replicated across vast pools of capital.
The beneficiaries, in Invesco's view, are familiar rivals: the euro, the yen and a range of emerging-market currencies. Dollar weakness tends to flatter assets elsewhere, particularly in countries burdened by dollar-denominated debt. The firm sees emerging-market local-currency debt, China excluded, as especially attractive. Commodity-linked assets, too, often enjoy a lift when the dollar falls, since many raw materials are priced in greenbacks.
American equities may not be immune. In absolute terms a softer dollar can bolster multinational earnings. But Invesco cautions that higher long-term bond yields could offset that benefit. Currency weakness born of declining confidence is rarely an unalloyed good.
Lloyds Bank argues that the Federal Reserve's recent decisions have further undermined the currency's fundamentals, leaving little scope for a renewed rally. The macroeconomic mix confronting the dollar, Lloyds says, is unfavourable: a softening labour market, subdued inflation pressures and uncertainty over future Fed leadership. The central bank's latest 25-basis-point cut was accompanied by guidance widely interpreted as dovish. Analysts expect further reductions next year unless inflation delivers an unwelcome surprise.
Even then, Lloyds doubts the Fed would swiftly return to tightening. Any inflation shock, it argues, would more likely be met with tolerance rather than aggression, at least initially. That could steepen the yield curve as investors demand higher compensation for inflation risk at longer maturities. But a steeper curve driven by inflation anxiety is not, Lloyds notes drily, an environment that usually favours the dollar.
Compounding the problem is what the bank describes as a “very skinny” dollar risk premium. After a modest recovery over the summer, the currency appears to have exhausted its cyclical support. Geopolitical tensions add another layer of fragility.
Structural imbalances at home do little to help. Labour-market fragility, a squeeze on capital expenditure and persistent weakness in housing may yet require lower policy rates. Such a scenario would, in Lloyds's telling, push the remaining dollar premium into deficit and force a broader repricing. The bank continues to favour the euro, Norwegian krone, Swiss franc and Australian dollar against the greenback.
The impact is visible in GBP/USD. Sterling's recent advance was reinforced when the Fed cut rates and hinted at further easing in 2026. The pound climbed from below $1.33 to around $1.34 after Powell struck a notably relaxed tone on inflation.
A combination of benign inflation and rising unemployment is catnip for monetary doves. It strengthens the case for further rate cuts, weighing on American bond yields and, by extension, the dollar. The Fed's own projections, summarised in its “dot plot”, showed little change in policymakers' expectations, reinforcing the view that another cut early in 2026 is likely.
UBS notes that softer inflation, looming changes at the Fed, shifts in the composition of the Federal Open Market Committee and the timing of upcoming employment data all point in the same direction. Absent a sharp upside surprise in jobs figures, the bias remains towards dollar weakness into year-end.
None of this amounts to an imminent dollar crisis. USD remains the world's dominant reserve asset, backed by deep markets and formidable institutions. But dominance isn't forever. As America's interest-rate exceptionalism fades, gravity may reassert itself.
The dollar's likely decline looks less like a rout than a steady erosion, driven by narrowing yield gaps, changing hedging behaviour and a more candid Federal Reserve. For years, investors have been paid handsomely to hold dollars. In the coming quarters, they may find the compensation less compelling. The greenback, long accustomed to privilege, is discovering what it is like to be merely normal.
