Interview, Fireside Chat
Why the Dollar Could Drop
- The dollar is projected to face continued depreciation in the first half of next year, with fair value models suggesting a range of 5 to 10 percent and potential for overshooting if pent-up foreign hoarding by pension funds and corporations unwinds.
- Currency weakness is anticipated to be contingent on specific country profiles, with the DXY trade-weighted index expected to hover within 50 basis points of current levels despite short-term volatility.
- Market dynamics for the next two years are expected to favor the appreciation of the Chinese and Brazilian currencies, with Brazil having already appreciated 17% in spot returns and nearly 30% in total returns year-to-date.
- Japan is expected to adopt looser fiscal policy under Prime Minister Takeichi over the next couple of years, potentially revitalizing the "debasement trade" linked to fiscal sustainability concerns in the U.S., UK, and France.
- The primary catalysts for further dollar depreciation are expected to be the resumption of U.S. labor market data and the Trump administration's nomination of a new Federal Reserve chair, which could significantly alter the outlook for the next year of Fed policy.
- While the market coalesces around an expectation of a rate cut next week, the communication regarding the inflation versus unemployment balance and the "dots" path for 2026 are expected to have a more significant impact on the dollar than the immediate cut itself.
- There is currently estimated to be less than a 50 percent probability of another Fed cut in January, a figure anticipated to shift notably following the Fed chair's press conference on inflation and unemployment risks.
- Emerging market carry trades are expected to remain the preferred strategy for expressing dollar weakness in the first half of next year, with Brazil, Mexico, and the South African rand identified as primary components.
- Options market pricing indicates a scenario of contained Chinese currency appreciation characterized by all-time lows in volatility, with a "dollar-China lower" strategy expected to be a favored trade going into 2026.
- The overarching thesis suggests a reduction in expected exceptional returns from the U.S. economy, diminishing the rationale for maintaining the over-allocated U.S. positions that have been held for the past 15 years.