Source: Bloomberg / Validus

Seeing both EURUSD and GBPUSD off their highs, we find ourselves questioning whether we should expect a stronger dollar going forward and into 2026 or whether further declines are likely in the months ahead?

Regular readers will know that our bearish view on the dollar dates back long before Trump took office in January. Our rationale for the view was as follows:

• The dollar has been overvalued on most purchasing power parity metrics for some time and history tells us that currencies have tended to mean revert over the medium to long term.
• Even before he took office, Trump was advocating for considerably lower interest rates. Whilst that is yet to materialise, concerns about the Fed’s independence have weighed on sentiment.
• Ballooning deficits have long had the potential to destabilise US debt markets. While the US has benefited from exorbitant privilege in recent decades, we continue to think there is a good chance that it won’t continue indefinitely.

All three factors remain a consideration, so for now, we see little reason to change our long-standing view. If anything, the events and market reaction over the first six months of 2025, adds confidence to our view for a weaker dollar in the medium to long term. We know markets rarely move in straight lines and trends will go through periods of correction or consolidation, but we try to look beyond short-term noise. That said, there are a few factors worthy of consideration. 

1. The dollar is nowhere near as undervalued as it was at the start of the year. History tells us that +/- 20% divergences from fair value tend to be short lived. However, both the euro and the pound are currently ~10% undervalued against the dollar and hence the argument for a significantly weaker greenback going forward isn’t anywhere near as strong as it was previously.  
2. Secondly, markets seem to have digested Trump’s tariff policies and concluded that global trade can and continue after all. Granted it may not be as smooth as before, but still smooth enough for equity markets to be making new record highs.
3. The rest of the world has financed US deficits for years so what’s to say that it won’t do so for a bit longer? The lack of alternatives to the Treasury market and the resilience of US equities suggests that the is plenty of appetite for US Government debt.

For now, markets aren’t giving us any obvious warning signals. Positioning in the futures market is far from extreme in both EURUSD and GBPUSD while the options markets are fairly neutral in terms of skew. It is marginally more expensive to protect against the downside in GBPUSD, but that is no doubt a reflection of uncertainty surrounding the upcoming UK budget as opposed to expectations of a broadly stronger dollar.

Our latest forecasts are set out below: