US Dollar Poised for Largest Annual Decline Since 2003

Geopolitics, diversification, and Fed easing contribute to the U.S. dollar’s downward pressures.

While the so-called Santa Claus rally delivered year-end gains for stocks and precious metals, the U.S. dollar received a lump of coal to finish a not particularly strong 2025.

The U.S. dollar index, a measure of the greenback against a weighted basket of currencies, is on track for its largest annual decline since 2003.

This year, the index has dropped 10 percent, with nearly all of the damage occurring in the first half of 2025, when it tanked almost 11 percent. The alternative trade-weighted dollar index—a measure created by the Federal Reserve that monitors the greenback against major trading partners—has declined about 7 percent.

The greenback has steadied in recent months, with ING strategists noting that “the dollar is proving surprisingly resilient” amid various data points.

Still, analysts are divided on whether the worst has passed or further weakness awaits in 2026.

Over the past 12 months, the dollar’s downward pressure has been driven by a broad array of headwinds, including global diversification, geopolitical tensions, and Federal Reserve easing.

Global private investors and central banks have engaged in a balancing act: bolstering their appetite for non-dollar assets—gold or alternative currencies—and increasing their exposure to high-yield U.S. Treasury securities.

Foreign holdings of U.S. debt, for example, rose 6 percent year over year in October to $9.242 trillion, according to Treasury data released earlier this month.

In the year ahead, similar trends could play out, say ING strategists.

“This year has shown that the private sector is more than willing to buy Treasuries and our call for a weaker dollar in 2026 is based on foreign investors increasing their hedge ratios on U.S. assets rather than selling them outright,” they wrote in a Dec. 19 note.

Geopolitics and fiscal concerns are likely supporting the continued diversification, say UBS economists.

Washington registered a $1.8 trillion budget deficit in fiscal year 2025. The federal shortfall is already $439 billion in the first two months of fiscal year 2026, and the deficit could be on track for another $2 trillion.

Persistent fiscal worries continue to keep long-term Treasury yields above 4 percent.

As the U.S. administration embarks on a rebalancing of international trade through tariffs and efforts to end multiple conflicts, geopolitical tensions could remain elevated.

Central Bank Divergence

The Fed, meanwhile, is firmly entrenched in its easing cycle, following through on three quarter-point rate cuts in 2025. These actions have lowered the benchmark federal funds rate to a new target range of 3.5–3.75 percent—and further easing could be ahead.

Monetary policymakers have penciled in a single rate action next year. However, new CME FedWatch Tool data show that investors are forecasting two or three cuts beginning in the spring.

In addition, once Chair Jerome Powell’s term expires in May, uncertainty looms in the back half of 2026, as President Donald Trump’s pick is widely expected to advocate for aggressive rate cuts.

Predictive markets say Powell’s successor likely will be either National Economic Council Director Kevin Hassett or former Fed Governor Kevin Warsh—with the odds in Hassett’s favor.

Conversely, there is a monetary divergence among other major central banks that could add further pressure to the greenback.

The Bank of Japan, for example, recently raised its policy rate to the highest level in 30 years. If above-trend inflation persists, Japanese monetary policymakers expect more rate hikes next year, sending long-term yields on government bonds to 2–3 percent.

Central bank interventions have allowed the Japanese yen to strengthen against the U.S. dollar, rising about 0.5 percent year to date.

Since 2023, the European Central Bank has been engaged in an ongoing easing cycle. However, officials have closed the door to further rate cuts this month, having upgraded their inflation and growth outlook. Investors are betting on a 30 percent chance of rate hikes in the latter half of 2026, a move that would widen the gap between the euro and the dollar.

“With the Fed expected to ease further into 2026, this is eroding the U.S. interest rate premium versus global peers and looks likely to add pressure on the U.S. dollar,” UBS economists wrote in a Dec. 22 note.

The dollar index ticked up 0.05 percent during the quiet Boxing Day trading session, hovering around 98.00.