The US dollar is poised for its most significant annual decline since 2017, currently on the back foot as market sentiment points towards further interest rate cuts from the Federal Reserve next year.
This outlook persists despite robust US GDP figures released on Tuesday, which failed to alter investor expectations for monetary policy.
Analysts are now pricing in approximately two additional Fed rate reductions in 2026.
David Mericle, Chief US Economist at Goldman Sachs, commented on the situation, stating: “We expect the FOMC to compromise on two more 25 bp cuts to 3-3.25 per cent but see the risks as tilted lower. He attributed this forecast to slowing inflation.
The euro and pound each nudged up to fresh three-month highs on Wednesday, though were last broadly steady on the day at $1.180 and $1.3522, respectively.
Against a basket of currencies, the dollar index =USD fell to a 2-1/2-month low of 97.767.
It was on track to lose 9.8 per cent for the year, which would mark its steepest annual drop since 2017. Any further weakness in the last week of the year would take its fall to its greatest since 2003.
The dollar has had a tumultuous year, whipsawed by President Donald Trump’s chaotic tariffs that sparked a crisis of confidence in U.S. assets earlier this year, while his growing influence over the Fed has also raised concerns about its independence.
In contrast, the euro is up just over 14 per cent for the year thus far, putting it on track for its best performance since 2003.
The European Central Bank stood pat on rates last week and revised upwards some of its growth and inflation projections, in a move that likely closes the door to further easing in the near term.
Traders have since responded by pricing in a slim chance of tighter policy next year, mirroring expectations for Australia and New Zealand, where the next moves are seen as being hikes.
That has in turn lifted the two Antipodean currencies, with the Australian dollar AUD=, up 8.4 per cent to date, scaling a three-month peak of $0.6710 on Wednesday, and the New Zealand dollar NZD= similarly touched a 2-1/2-month high of $0.58475.
Sterling GBP= has gained more than 8 per cent for the year. Investors are betting the Bank of England will deliver at least one rate cut in the first half of 2026, and place a roughly 50 per cent chance on a second before the year-end.
However, most currencies have lost significant ground versus precious metals such as gold, which touched a fresh record high on Wednesday.
Currencies of smaller European countries, often with low debt, have been among the best performers this year.
The dollar has shed 12 per cent on the Norwegian crown, 13 per cent on the Swiss franc — to last trade at 0.7865 francs – and 17 per cent on the Swedish crown, hitting its lowest since early 2022 on Wednesday at 9.167 crowns.
Traders on Yen intervention alert
For now, the main focus for the foreign exchange market remains on the Japanese yen, with traders alert to the possibility of an intervention from Japanese authorities to stem the currency’s slide.
Finance Minister Satsuki Katayama said on Tuesday that Japan has a free hand in dealing with excessive yen moves, issuing the strongest warning to date on Tokyo’s readiness to intervene.
Her remarks arrested the yen’s decline, with the dollar last down 0.3 per cent on the Japanese currency JPY= at 155.83 yen on Wednesday, having fallen 0.5 per cent in the previous session.
While the Bank of Japan delivered a long-anticipated rate hike last Friday, the move had been well-telegraphed and comments from Governor Kazuo Ueda disappointed some in the market who had been betting on a more hawkish tone, leaving the yen sliding in the aftermath.
That has left investors vigilant to official yen-buying from Tokyo, particularly as trading volumes thin towards the year-end, which analysts say would make an opportune time for authorities to strike.
