We do not expect a quiet new year; instead, we see a range of factors that could influence volatility in the currency market. On one hand, there are the growth prospects of key economies—the USA, the Eurozone, the UK, and China. On the other, there are central bank decisions and even personnel changes at the Federal Reserve. Let’s look at 8 key aspects for the upcoming 12 months.
We entered 2026 with a series of uncertainties still hanging over the markets. Although President Trump’s crusade on the trade policy front is largely behind us, we have not yet seen the full impact of greater trade restrictions on the global economy. It will take some time before the ripple effects (potentially delayed) of import tariffs are fully visible in the economy. This could take a few years or longer. Businesses initially absorbed some of the rising costs, while companies and consumers partially shielded themselves from the burden of Trump’s protectionist policies through front-loading purchases.
The response of individual economies to tariffs will be key to monetary policy paths in 2026. We expect economic growth to be resilient this year, partly thanks to the normalization of living costs and the effects of easing policies already enacted. Additionally, AI investments, particularly in the US, should provide support. Inflation may remain sticky due to tariffs introduced last year and demographic changes in the labor market. However, central bank targets will, in our view, be within reach, and many policymakers will consider whether this is the appropriate time for interest rate hikes. In the US, the situation will be clouded by changes in the composition of the Federal Open Market Committee (FOMC), especially given that Jerome Powell’s term as Fed Chair ends in May.
Below, we describe what we believe investors will focus on this year. We also present factors that may drive volatility in the currency market.
Global growth should be resilient in the face of the AI boom
Global growth was surprisingly resilient in 2025—most economies handled the tariff storm well, aided by solid labor markets, a general decline in inflation, and more accommodative monetary and fiscal policies. We expect growth to remain resilient in 2026 as well. Uncertainty should continue to weigh on trade, but we regard the bleakest scenarios assuming a significant slowdown in global activity as unrealistic given the lifting of the most draconian trade restrictions. Lower central bank interest rates should be crucial for achieving solid growth dynamics, especially considering the lagged impact of cuts on the economy.
Key to this is how AI will affect the global economy. Those hoping for an immediate explosion in growth thanks to the development of artificial intelligence will have to wait a while, as significant productivity improvements may take years. However, AI investments themselves can boost GDP growth, while early signs of operational improvements (e.g., elimination of routine tasks and better resource management) may lead to slight efficiency gains. This should support developed markets rather than developing ones, with the US and China—world leaders in AI spending—likely gaining the most this year.
As labor markets are likely to cool this year (the US and UK markets seem particularly fragile), fiscal spending should act as a growth buffer. However, this will vary between countries, with Europe being a prime example. Nations with low debt levels (e.g., Germany and Scandinavian countries) will be in a good position to spend significantly, while the maneuvering room for more indebted ones (Italy, France, etc.) will be much smaller. The situation is worsened by the clear inability of authorities in the common bloc to enact pension reforms. Currently, the system heavily burdens the working-age population to finance benefits for a growing percentage of recipients—a problem that is not unique to the Eurozone.
Major Central Banks will turn hawkish
As is usually the case, the monetary policy path of the largest central banks will be key for financial markets this year. In G10 economies, most of the easing is already behind us. It appears the ECB has already finished its cutting cycle, the Fed and the Bank of England have little left to do (at most 1 to 2 cuts), while a handful of others (including the Reserve Bank of Australia, the Reserve Bank of New Zealand, and the Bank of Canada) are expected to reverse course in 2026. We believe that before the end of the year, interest rates will not only reach their minimums, but economic conditions may, in some cases, justify moderate tightening.
Many developed economies may still face elevated inflation. A potential drop in energy prices, supported by a ceasefire between Russia and Ukraine, could lead to a decline in headline inflation in these economies. However, core inflation will likely remain sticky, especially in the services sector. Furthermore, wage inflation may persist due to relatively tight labor markets. Additional arguments for bank hawkishness include US tariffs and a decline in Fed independence.
We will be watching the impact of a potential hawkish pivot on global bond yields exceptionally closely. Financial markets obviously look forward, so even a slight shift to the hawkish side could cause yields to rise at the short end of the curve (and potentially at the long end if inflation expectations become unanchored). A gradual and controlled rise in yields linked to expectations of strong growth or slight rate hikes would not be surprising; however, a sharp move would be a warning signal, given the impact of yields on equity valuations, debt costs, and recession risk. Central bankers should proceed with caution.
The issue of debt dynamics also poses a significant risk for yields—governments of many developed economies face huge fiscal deficits and high debt-to-GDP ratios. The growing need to borrow due to an aging population, shrinking workforce, and a shift toward anti-immigration policies should lead to further debt issuance and additional upward pressure on yields, especially as governments struggle to push through even small cuts to social spending. A significant rise in long-term bond yields constitutes probably the biggest risk to our forecasts for the global economy in 2026.
Will the Dollar remain weak?
Despite significant depreciation of the dollar in 2025, we remain negative on it. Trade uncertainty has decreased but hasn’t disappeared completely. We believe tariffs will maintain a risk premium on the dollar, even if it is small. It is also probable that the US labor market will continue to cool, especially as the economy adjusts to lower immigration, the AI industry boom, and demographic changes, mainly an aging workforce. So far, data indicates the economy is in a “no hire, no fire” state. While we do not expect a very significant deterioration, it is worth noting that hiring freezes often precede a rise in layoffs.
The fears mentioned above regarding a tariff-induced inflation spike are proving unjustified for now, especially given the much stronger-than-expected drop in November (the data miss was one of the largest in recent years). However, we believe the Fed will not draw hasty conclusions, given that disruptions related to the government shutdown likely artificially lowered the reading. Nevertheless, it should continue interest rate cuts as inflation falls and the labor market experiences cooling. We expect at least two cuts this year, a pace faster than presented in the December dot plot. We expect this to support downward pressure on the dollar.
Clash of the Kevins: The new face of the FOMC
Uncertainty regarding the composition of the FOMC will be crucial for markets this year, as it will influence not only the path of US interest rates but also the degree to which the Fed can maintain independence. Understandably, attention will focus on who replaces Chair Jerome Powell after his term ends in May. According to pricing on Polymarket, the dovish Trump ally, Kevin Hassett (40%), still leads, followed closely by Kevin Warsh (37%). Hassett taking the chair does not seem as certain as it recently did, especially given rumors that high-ranking officials in the Trump administration opposed the prospect of his appointment.
We do not believe an FOMC led by Hassett (or Warsh, for that matter) will significantly change the trajectory of interest rates, despite his clear dovish leanings and past favorability toward looser monetary policy. After all, the new Chair will be just one voting member and may find it difficult to sway others to his side, while concerns about the bank’s credibility should limit any politically motivated influence on monetary policy. The annual rotation of voting members taking place this month should also be a balancing factor, as three out of the four new voters (Beth Hammack, Lorie Logan, and Neel Kashkari) are perceived as hawks.
Both the vision of an FOMC led by a Trump ally and concerns regarding Fed independence support our view of dollar weakness. Notably, yields on long-term US Treasury bonds continue to rise despite the Fed’s recent dovishness. So far, US inflation expectations have remained contained, but this could change if Trump’s influence on Fed monetary policy becomes more visible. In this regard, the Supreme Court decision regarding regional Fed bank president Lisa Cook, likely expected in Q2, will be key.
German stimulation will kickstart the Eurozone recovery
We have a moderately optimistic view of the Eurozone economy in 2026. Recent activity indicators suggest it is performing relatively well, with economic growth exceeding earlier ECB projections. It seems robust domestic demand is balancing the blow dealt by higher US tariffs—given limited inflationary pressure, particularly the drop in energy prices, and lower debt servicing costs, we expect this trend to continue. We also see signs that the common bloc’s economy has quickly adapted to tariffs, limiting export losses through greater diversification, particularly by strengthening trade links with Asian markets.
Activity should be strongly supported by the €500 billion fiscal stimulus in Germany. Announced last year, we are still waiting for its full effects (the multiplier for such stimulus is usually high but reveals itself slowly). We expect these actions to be reflected in 2026 through growth in employment, investment, and local consumption, which should translate into stronger economic growth in the Eurozone (where Germany’s weight is 25–30%). The combination of infrastructure improvements, a solid labor market, looser monetary policy, and greater AI investment could, in our opinion, lead to a moderate upside surprise in growth dynamics this year—especially if the negative effect of tariffs fades faster than expected.
The UK economy will lag behind due to growing fiscal problems
It seems that after a good start to 2025, activity in the UK has stalled. The economy recorded barely noticeable growth of 0.1% in Q3, and the Bank of England currently expects dynamics to have flattened at the end of the year. The recent rise in the composite PMI suggests the situation isn’t dramatic, yet stagnation is the ceiling for Q4. The surprising GDP fall in October (-0.1%) indicates that uncertainty regarding the autumn budget weighed on the economy even before Chancellor Rachel Reeves took the podium.
The Monetary Policy Committee said in December that the budget would have a “marginally positive” impact on UK growth in 2026. We do not share their optimism and can only surmise their assessment is based on the belief that the budget should be deflationary, which in turn could support activity. We see few things in the budget that can be unequivocally considered supportive of growth. With the tax burden at its highest level in peacetime, we rate the risk of crowding out private investment higher. We are not convinced that increased social spending will provide net support for growth, especially given the generally low multiplier (translation to GDP) for social security spending in the UK.
Tax hikes will be largely deferred, meaning the increase in the burden on citizens will be small in the coming financial year. However, businesses and consumers do not react only to current economic conditions but rather make spending and investment decisions based on expectations for the future. We have already observed a sharp cooling of the labor market (187k vacancies lost since the 2024 budget), and we expect conditions to remain difficult this year as well, which may result in weaker household consumption and slow economic growth.
The outlook for 2026 is not entirely devoid of optimism, however. Inflation in the UK has passed its peak and should continue falling this year toward the Bank of England’s target—in November, for the first time in six months, its reading was closer to 3% than 4%. This should help reduce pressure on real incomes and household purchasing power, especially since nominal wage growth will likely remain relatively high. However, a range of risk factors for the outlook has caused us to recently revise our forecasts for the pound downward.
China: Schrödinger’s Economy
Market fears regarding China’s economic growth prospects rose after Trump’s presidential election win, peaking after “liberation day” in April. Since then, Chinese exports have shown remarkable resilience—aided by greater diversification into non-US markets, exports through third countries, and competitive pricing. Additionally, exports have become more comprehensive in recent years, increasing China’s integration into global supply chains.
Strong export results and subsequent upside surprises in GDP readings mean the “approx. 5%” growth target was likely achieved in 2025. Despite this, domestic demand remains weak, the property market crisis continues to erode confidence, and youth unemployment remains elevated. Deflationary pressure also persists, though its decline is supported to some extent by the domestic anti-involution campaign (aimed at limiting excessive price competition).
In the context of China, two questions are important to us:
1. Will authorities place greater emphasis on supporting domestic demand, or will the export-based model clearly dominate?
2. How will the economic rivalry between the USA and China play out?
Short-term prospects suggest continuity and only a gradual slowdown in growth. Actions to support domestic demand, including the extension of the successful trade-in program for 2026, are beneficial but still seem limited in scope. More decisive stimulation cannot be ruled out, as concerns regarding domestic demand seem to be gaining importance. Tensions with the US eased after the signing of a trade truce in late October and suggestions that further meetings between Trump and Xi will take place. However, a range of significant problems remains unresolved.
The Yuan was relatively weak in 2025, and the USD/CNY rate was allowed a limited decline. Looking at fundamentals, we see further upside potential for the Yuan, which may record further gains against the dollar this year. However, given that most other currencies should strengthen against the US currency, and price pressure in China is limited, the real effective exchange rate will likely support the competitiveness of Chinese exports.
Favorable outlook will support Emerging Market currencies
We believe most emerging market currencies should continue their good streak from 2025. A weaker dollar, especially under pressure due to additional Fed rate cuts, should provide them with support. A large portion of EM currencies should remain attractive in terms of carry trade—many (especially in Latin America) offer high real rates of return. Economic growth in emerging markets should remain at good levels, especially considering last year’s monetary easing and significant drops in inflation, which is now under control in many countries. This decline in price pressure, in particular, should support the attractiveness of investments in developing markets.
The significant diversity of emerging markets naturally implies a significant divergence in EM currency performance. We are very curious whether the rapid expansion of the AI sector will translate into a widening of these differences—it seems that some Asian economies (mainly China, India, Singapore, Malaysia, and South Korea) are well-positioned to benefit from AI-related growth support. However, rising geopolitical risks may hinder them, particularly the increase in trade tensions between the US and China and the aggravation of the situation in the Middle East (recent news from Venezuela serves as a clear warning that investors should remain vigilant).
Expect another year full of significant changes, which will not be characterized by the calm and stabilization so desired by market participants.
