Dollar faces mild headwinds as Asia gains momentum

As we cross into 2026, currency markets face a paradoxical backdrop: global growth is well below trend, yet business and consumer confidence have rebounded sharply. Central banks are cutting rates into non-recessionary environments, real rates are edging lower, and fiscal stimulus is expected to lift growth across major economies.

Mild dollar weakness emerges as central theme

The US dollar is expected to experience modest depreciation of approximately 3-4% against G10 currencies in 2026, driven by the twin themes of front-end compression amid bullish cross-currents of investment. This reflects a well-established foundation where rate differentials between the US and developed markets are compressing as the Federal Reserve may deliver two to three rate cuts through the year, while other major central banks hold or move more cautiously.

"Lower volatility and dollar weakness is our central scenario. Competing flows act as a partial offset to the FOMC rate cuts, which is ultimately what's driving our view."

-Richard Cochinos, FX Strategist, RBC Capital Markets

Forward markets are already pricing in modest USD weakness of approximately 1.3% through 2026, with cumulative weakness of approximately 2.0% by end-2027. This represents a remarkably contained move given the historical volatility associated with similar policy divergences. The magnitude of expected weakness sits at the lower end of historical precedent for rate-cutting cycles, reflecting the unique backdrop of continued US asset outperformance.

However, the path to depreciation may not be linear. The US economy is expected to grow at approximately 2% or greater, well ahead of Europe and most developed markets. This growth differential and asset performance dynamic will continue to attract capital inflows to US equities and credit, creating episodes of dollar strength even as the underlying trend tilts toward currency weakness.

"The US dollar index has been clinging to a key long-term support level, and a monthly close below that 97.20 level would essentially confirm a bearish long-term trend reversal for the US dollar."

-George Davis, Technical Strategist, RBC Capital Markets

Asian currencies positioned for strength

The outlook for Asia as a region remains notably positive, with the bullish Chinese yuan outlook expected to radiate outward. The People's Bank of China is likely to guide USD/CNY gradually lower over the next few months, with potential fiscal stimulus and associated equity inflows driving further yuan appreciation.

Chinese yuan strength creates a supportive backdrop for exporter currencies across the region. Malaysia, Taiwan, and Australia are particularly well-positioned to benefit from this dynamic. The yuan's role as the anchor currency for the region means its appreciation sets the stage for broader Asian foreign exchange strength.

Fiscal stimulus from Beijing would significantly improve the cyclical outlook for China, resulting in sizeable equity inflows and further yuan appreciation. Such measures would translate into improved external demand across Asia-Pacific, from Korean electronics to Indonesian commodities, boosting the outlook for regional currencies.

Carry trades maintain remain attractive amid steady interest rates

Foreign exchange carry strategies are likely to remain an important portfolio driver into 2026, given that no clear catalyst exists for higher volatility and interest rate levels remain sufficiently wide globally. Expected central bank policy changes are unlikely to alter these dynamics materially.

"Carry was a big driver and an important theme for the second half of 2025, and that's a theme we expect to carry over into the early part of 2026."

-Daria Parkhomenko, FX Strategist, RBC Capital Markets

The Swiss franc and Canadian dollar screen as the most efficient funding currencies for carry positions, while Brazilian real and Mexican peso positions appear attractive against European counterparts.Investors should exercise caution with Hungarian forint positions due to political volatility expected in the first half of 2026.

Inflation divergence shapes central bank policy

Countries are experiencing increasingly divergent inflation dynamics, creating scope for central bank policy divergence. While individual central bank policies may not be the primary driver of currency movements, global inflation regimes can provide better guidance for medium-term performance.

If economic conditions align with a "stagflation lite" environment in 2026 - combining below-trend growth with elevated inflation - historical patterns suggest this could provide some support for the dollar. However, this support faces headwinds from foreign exchange hedging flows.

Political dynamics create opportunities

Emerging market elections will bring both uncertainty and strategic positioning opportunities to foreign exchange markets. Elections in Brazil, Peru, Colombia, and Hungary are expected, with right-wing governments likely to gain momentum across Latin America.

"Regardless of the outcome, we think Brazil can gain 6% in 2026 and would still have at least 8% carry, making it one of the most interesting and preferred currencies in emerging markets."

-Luis Estrada, LatAm FX Strategist, RBC Capital Markets

Despite political uncertainties, institutional development in major emerging market economies has significantly reduced election-related risks over the past decade.

While any election brings volatility, investors should not harbor a bias to avoid country exposure during election years due to perceived extreme risks. Over the last decade, institutional and individual development in some EM countries has reshaped these risks. As institutions continue to evolve, the gap between emerging market and developed markets will narrow further, transforming how investors assess risks and potentially unlocking new opportunities in currency markets.