The U.S. dollar started 2026 the way it ended 2025—on the back foot. The greenback fell to around 98.2 on the Dollar Index on the first trading day of the new year, building on what was its steepest annual decline in eight years. The currency shed approximately 9% in 2025, weighed down by policy uncertainty, Federal Reserve rate cuts, and growing concerns about fiscal deficits.

For American investors, a weaker dollar is a double-edged sword that will reshape portfolio returns in ways many haven't considered. Understanding these dynamics is essential for navigating 2026's investment landscape.

What Drove the Dollar's Decline

Several converging factors pushed the greenback lower throughout 2025:

Federal Reserve Rate Cuts

The Fed cut interest rates three times in 2025, bringing the federal funds rate to a range of 3.50%–3.75%. Lower rates reduce the yield advantage that made dollar-denominated assets attractive to global investors, weakening demand for the currency.

Narrowing Yield Differentials

As U.S. rates fell while other major central banks held steady or tightened, the interest rate differential that supported the dollar narrowed. International investors found better yields elsewhere, reducing dollar demand.

Tariff Policy Uncertainty

President Trump's tariff measures created economic uncertainty that weighed on currency sentiment. While tariffs can theoretically support a currency by reducing imports, the broader uncertainty about trade policy had the opposite effect.

Fiscal Concerns

Growing worries about U.S. fiscal deficits and the ballooning national debt have made some investors question the dollar's long-term store-of-value status. The "One Big Beautiful Bill" stimulus package added to deficit concerns.

Fed Independence Questions

With Fed Chair Jerome Powell's term expiring in May and Trump expected to name a successor, investor concerns about central bank independence have weighed on the currency. Historically, perceived threats to Fed autonomy have been dollar-negative.

Wall Street's 2026 Forecasts

Most major banks expect continued dollar weakness, at least through the first half of 2026:

  • Morgan Stanley: Sees the Dollar Index falling to 94 in the second quarter before rebounding to 100 by year-end
  • ABN AMRO: Notes the dollar is overvalued and expects more weakness in 2026
  • J.P. Morgan: Forecasts EUR/USD climbing to 1.22 by March and USD/JPY falling to 139

Cornell economist Eswar Prasad captured the consensus view: "Logically, the dollar ought to weaken, because it looks like there will be economic as well as political pressures in the U.S. to cut interest rates, while at the same time other major central banks could be moving in the other direction."

What a Weaker Dollar Means for Your Investments

International Stock Gains Get a Boost

When the dollar weakens, returns from international investments get translated back to dollars at more favorable rates. An investor holding European stocks doesn't just benefit from price appreciation—they also benefit when those euros are worth more dollars. This effect alone can add several percentage points to international returns.

U.S. Multinationals May Benefit

Companies that earn significant revenue overseas—think Apple, Microsoft, and Coca-Cola—see their foreign earnings worth more when converted to dollars. This currency tailwind can boost reported earnings and support stock prices.

Commodities Generally Rise

Most commodities are priced in dollars. When the dollar weakens, commodities become cheaper for foreign buyers, typically supporting demand and prices. Gold's historic rally has been partly attributed to dollar weakness.

Emerging Markets Get Relief

Many emerging market countries have dollar-denominated debt. A weaker dollar makes that debt easier to service, reducing default risk and supporting emerging market assets. This explains why emerging market stocks often perform well during periods of dollar weakness.

Domestic Purchasing Power Declines

The flip side of a weaker dollar is that imports become more expensive. From electronics to automobiles to clothing, goods made overseas will cost more, contributing to inflation and reducing the purchasing power of dollar savings.

Portfolio Adjustments to Consider

Given the dollar's trajectory, investors might consider several adjustments:

Increase International Exposure

If you've been underweight international stocks—as many American investors are—a weaker dollar provides an additional reason to diversify globally. Both developed and emerging markets could benefit from continued dollar weakness.

Consider Unhedged International Funds

Many international ETFs offer currency-hedged versions that neutralize exchange rate movements. In a falling dollar environment, unhedged funds capture both equity returns and currency gains. However, this cuts both ways if the dollar rebounds.

Review Commodity Exposure

Dollar weakness supports commodity prices. If your portfolio lacks commodity exposure, precious metals, energy stocks, or broad commodity ETFs could benefit from the currency backdrop.

Be Cautious About Cash

Holding excessive cash in a weakening dollar environment means watching your purchasing power erode in real time. While cash provides safety, the opportunity cost rises when the currency is declining.

The Bull Case for the Dollar

Not everyone is bearish. Morgan Stanley notes that resilient U.S. economic growth, fiscal stimulus, and an end to the Fed's cutting cycle could send the dollar rebounding later in 2026. The dollar also tends to strengthen during periods of global risk aversion, acting as the world's "shock absorber."

If recession fears materialize or geopolitical tensions escalate, global investors may reach for dollar liquidity first, potentially reversing the greenback's decline.

The Bottom Line

The dollar's 9% plunge in 2025 was a wake-up call for investors who had grown accustomed to a strong greenback. While forecasts point to continued weakness, currency markets are notoriously difficult to predict, and a reversal remains possible.

For most investors, the key isn't trying to time currency movements but ensuring their portfolio is positioned to weather various scenarios. Adequate international diversification, some commodity exposure, and a realistic assessment of cash holdings can help portfolios navigate whatever the dollar does next.

The era of easy dollar strength may be ending. Investors who adapt their strategies accordingly will be better positioned for whatever 2026 brings.