The dollar appears weakened, the euro dominant. But beneath the surface, dynamics are shifting. Between real yields, monetary cycles, and technical imbalances, 2026 could defy expectations.
2025 left a clear mark on currency markets. The US dollar lost significant ground, while the euro benefited from a surprisingly favorable environment.
Investors in the United States—whether in equities or Treasuries—noticed: nominal returns were sometimes strong, but outcomes were often disappointing once measured in domestic currency. In Europe, the picture appeared more straightforward.
Equities advanced, bonds finally responded, and the single currency also rewarded foreign investors in relative terms. But it is precisely when consensus grows too comfortable that markets tend to reverse. Could 2026 mark a turning point for the dollar? And is the euro really as robust as it appears today?
The crucial role of real yields and capital flows
In 2025, the key issue was not US nominal yields, but real yields. Despite historically high Treasury rates, persistent inflation eroded real returns, making dollar-denominated assets relatively less attractive on a risk-adjusted basis. This imbalance prompted capital flows toward Europe, where inflation was more contained and real yields less penalizing.
The critical insight is that capital flows respond to real yield differentials, not merely to policy rates. In 2026, if the disinflationary trend in the United States continues as suggested by recent macro data, the scenario could shift dramatically. With nominal yields stable, a decline in inflation would restore US real yields to more competitive levels, potentially favoring the dollar. In this context, the greenback’s current weakness may be more cyclical than structural.
Technical extensions and imbalances on the DXY
Beyond fundamentals, the FX market tells a technical story. The dollar index (DXY) experienced a broad and sustained decline in 2025, breaching levels historically considered zones of medium-term equilibrium. Momentum indicators, such as the RSI, indicate an extreme oversold condition—a sign of abnormal deterioration rather than a simple orderly correction.
When a currency enters these oversold zones, the market becomes highly sensitive even to marginal catalysts. A radical macroeconomic shift is not required to trigger a technical rebound. Often, a rebalancing of speculative positions or a reassessment of interest rate differentials suffices. Even a partial recovery in the DXY would directly impact EUR/USD, reintroducing volatility to a cross that benefited from a nearly one-way trend in 2025.
Divergences among central banks and monetary policy
The third, often underestimated element is the divergence among major central banks. In the United States, the debate over rate cuts continues, but decisions are far from certain. Monetary policy direction will hinge not only on macro data but also on internal Federal Reserve deliberations. Any easing, if accompanied by rapidly falling inflation, may not weaken the dollar as much as markets currently anticipate.
In Europe, the situation appears more rigid. The European Central Bank seems committed to a more linear policy trajectory, leaving limited flexibility and prioritizing financial stability. This reduces the ECB’s maneuvering room amid a cyclical slowdown. Paradoxically, a US environment with more stable real yields—even with gradual cuts—could attract global capital more than a less dynamic European outlook.
The key takeaway: currency markets respond not to rate cuts per se, but to their quality. Cuts that enhance expectations for future earnings and financial conditions can strengthen a currency, especially if the economic cycle remains resilient.
EUR strong, or simply contextually favored?
The euro benefited from a rare convergence in 2025: capital inflows, relative macro stability, and dollar weakness. Yet a strong currency does not necessarily reflect structurally superior fundamentals. Should the growth differential swing back in favor of the US and real yields realign, the euro’s current strength may prove temporary.
Moreover, an excessively strong euro risks undermining European competitiveness, particularly in a still-fragile global environment. This represents an implicit ceiling on the trend, often overlooked during periods of currency exuberance.
So?
2026 may not deliver certainties, but transitions. The dollar and the euro appear to be telling divergent stories today, yet markets have a longer cyclical memory than often assumed. Rather than chasing unidirectional scenarios, it is essential to recognize asymmetries and risks hidden behind overly linear narratives. Understanding these dynamics does not mean predicting the market, but it does help avoid being caught off guard when trends reverse.
Original article published on Money.it Italy 2025-12-30 07:04:00. Original title: Il dollaro ha deluso nel 2025. Perché il 2026 potrebbe raccontare un’altra storia?
