As we make our way into 2026, FX analyst Joe Tuckey looks ahead at the key events, fundamentals and major movers that could impact currency exchange this year. First, we look back at last year’s events and some of the broader themes at play. We’ll then go into more depth on the main points to consider for the dollar, sterling and the euro.
- Major themes impacting USD in 2026
- Major themes impacting GBP in 2026
- Major themes impacting EUR in 2026
What happened in 2025?
From the outset, FX markets in 2025 were defined by one theme: volatility. A precipitous drop in the US dollar in response to the Trump ‘liberation day’ tariffs set the tone for a year of dollar weakness. Volatility decreased in the latter stages of the year as markets refocused on the slow and steady rate cut trajectory of the major central banks.
The ‘Sell America’ tariff response, which punished the dollar, was met concurrently with a stronger investment case in European assets. A reform of the ‘debt brake’ in Germany and wider European fiscal policy spurred meaningful gains in the euro. In the UK, solid early-year GDP growth, a patient stance on rate cuts from the Bank of England (BoE), and a wider ‘risk on’ move in many equity markets helped drive gains, before some sterling weakness emerged in the run-up to the autumn budget. This pre-budget period represented the peak of negative sterling sentiment, which has since alleviated as we move into 2026.
What are the key themes to consider in 2026?
The past decade has seen extraordinary drivers of FX volatility, from Brexit and the Covid pandemic to Russia’s invasion of Ukraine and the subsequent inflation shock that forced aggressive rate hikes. In the post-inflation phase, FX markets have been shaped primarily by expectations around disinflation and monetary-policy divergence, alongside rising US political risk linked to disruptive Trump policies.
Current FX volatility is relatively subdued, particularly when contrasted with the first half of last year. In fact, Q4 2025 saw the lowest realised volatility in EUR/USD since 2021, as per UBS. This is partly due to a lack of macro shocks/surprises, but also because there is not a huge divergence in rate policy and economic growth outlooks between the US, UK and Europe. In 2026, both the US and the UK are expected to pursue 0.5% of rate cuts. Similarly, when aggregating economic growth forecasts (from the OECD and the IMF), the UK and the eurozone are expected to grow by around 1.3% and 1.1% respectively this year, with the US closer to 2%.
In the Trump era, pockets of volatility can never be discounted, as seen already this year with manoeuvres in Venezuela, stated intentions toward Greenland and fresh attacks on Federal Reserve (Fed) independence. Looking ahead, particularly in the US, FX markets have plenty of landmines to negotiate; a new Fed chairman, geopolitical developments and November’s mid-term elections, to name a few, while in Europe, the evolving relationship with the US, Ukraine peace talks and the tangible impact of German fiscal stimulus are a few themes to monitor.
Central banks must balance the need to secure a return to the 2% inflation target with the risk that overly restrictive policy could undermine already fragile growth.
Major themes impacting USD in 2026
Fed chair/independence
2026 will see the arrival of a new Fed Chairman and the ongoing discussion around Fed independence. Of course, Trump is a well-known advocate of lower interest rates and spent much of 2025 lambasting current chair Jerome Powell for not cutting quickly or deep enough. Powell’s tenure ends in May. The recent nomination of Kevin Warsh has thus far been met with a positive dollar reaction. Warsh is seen as a less radical choice than some other candidates. Whilst he is not ideologically opposed to dovish rate policy, his previous rhetoric has been critical of the Fed’s balance sheet expansion in the form of Quantitative easing (QE). The spectre of him advocating Quantitative tightening (QT) is dollar supportive, making sense of the market reaction thus far.
The Fed and its chairperson should, by nature, act independently of the President and focus on their inflation/employment mandate. But it’s fair to say these are unprecedented times. The revelation that Trump pressured the DOJ to open a criminal investigation over Fed HQ renovations is being seen as an attack on Fed independence. If this investigation favoured the prosecutor, it could undermine the Fed, weaken the dollar, and raise concerns that the next Fed chair may bow to political pressure. Expectations of faster, deeper rate cuts may fuel near-term dollar volatility, while ironically boosting longer-term inflation expectations and bond yields. The timing of the new Fed chair announcement will be influenced by the ongoing legal machinations and should remain a key market driver in the first half of the year.
Tariffs
The initial, explosive impact on markets from ‘larger than expected’ tariffs has already been seen. Tariff developments should have far less impact on FX markets going forward than they did last April. However, recent threats of further tariffs on eight countries show that it remains a negotiating tool favoured by Trump. The US Supreme Court is presiding over a case challenging Trump’s authority to implement tariffs, with a ruling expected soon (but this could drag on further). Market commentators and betting markets (e.g., Polymarket) currently expect the legal challenge to be successful. If this was the case, implications for the dollar would be mixed; reducing trade tensions and policy clarity would be supportive, but the lower cost of imported goods would be disinflationary, potentially allowing further rate cuts.
Should the legal challenge fail, markets could assume Trump may impose fresh tariffs in certain sectors or regions (e.g. China, automotive, etc.). Interestingly, experts also suggest that Trump could implement a ‘workaround’ should tariffs be deemed illegal, which could take the form of import licensing and quotas.
Midterm elections
The midterm elections in November are typically viewed by markets in three phases: the run-up, the immediate post-election reaction, and the longer-term implications. Here are the potential developments in each stage.
Run-up: Risk premia often rise due to fiscal brinkmanship, shutdown risk, and potential policy reversals.
Reaction based on the following outcomes:
- Divided government: With policy gridlock, expect a lower risk of shocks. Neutral-to-slightly dollar-positive.
- Ruling party loses: With constrained executive power, there’s likely to be less aggressive protectionism. Generally, dollar supportive.
- Ruling party strengthens: A continuation of the status quo. Often negative for the dollar.
Long-term: Markets focus on fiscal outlook, trade policy, economic data, Fed policy, and broader macro trends.
Currently, political commentators see a risk that the Democrats could take control of the House of Representatives (HoR), with the Republicans retaining the Senate, meaning more obstacles to passing legislation. Given the risk of losing the HoR, Trump may be prompted to push his agenda more aggressively.
US economy/other factors
Concerning the overall US economy, markets expect solid, if unspectacular growth of “2.1% in 2026”. Recession odds are low but not negligible, “assessed at about 30 percent.” The Fed will remain data-dependent, responding to inflation and employment data, which are broadly cooling but still sticky in the service sector.
Last year, the Trump tariff saga drove simultaneous weakness in equities, treasuries and the dollar. Subsequent rollbacks alongside the AI boom drove significant gains in equities, but the dollar remained weak. Market participants re-engaged with long equities but hedged their dollar exposure (via forwards or swaps), keeping the currency under pressure. This may continue in 2026.
Speculators remained quite heavily short on the dollar for much of 2025, making it a consensus trade. Should stronger incoming US economic data drive the Fed to resist further rate cuts, this could fuel the unwind of short dollar positions, which would lend support to the dollar, even in the absence of particularly bullish fundamentals.
Major themes impacting GBP in 2026
Monetary policy
In the UK, as with the other regions mentioned here, Central Bank activity is a major driver of activity. The widely held view is that the BoE is likely to deliver two further 0.25% rate cuts in 2026, and most likely in the first half of the year, possibly at the February and April meetings. The end of 2025 saw a 0.25% cut but this was a close call. The Monetary Policy Committee (MPC) stated that easing is “likely to continue on a gradual downward path” but added that “judgements around further policy easing will become a closer call”. MPC members who voted for a cut last time also noted the strength of forward-looking wage growth indicators as a risk factor for inflation.
The expected terminal rate is 3.25%.
Elections
Scottish parliament elections and local elections will be held on May 7 2026.
Back in 2014, the lead-up to the Scottish independence referendum drove some downside sterling risk. It seems reasonable to assume the notion of Scotland breaking away from the UK would be seen as a downside risk factor for sterling once again, given concerns around the economic, fiscal and political impact, although this is something of a ‘tail risk’ event.
Scotland accounts for around 8% of UK GDP. Scottish independence would therefore reduce the size of the UK economy, tax receipts would decline, and questions over debt sharing would pose a risk. Any such process would take a long time to come to fruition, however and face significant legal challenges.
UK local elections will provide a ‘temperature check’ of the electorate’s views. It’s unlikely to be a major driver of currency volatility, but shifts in sentiment toward issues of European integration or political fragmentation could affect it.
Post-Budget Britain
Since the lead-up to last year’s Autumn budget, where positioning and sentiment were at their most negative, sterling can benefit from reduced fiscal vulnerability and a pro-risk environment:
- There’s now a reduced fiscal risk premium, given Reeves’s doubling of headroom. The Office for Budget Responsibility may shift to producing a single set of projections per year rather than two. This would help to reduce uncertainty for markets and businesses.
- Business investment growth has improved after flatlining following the Brexit referendum. This may lead to productivity gains, as the UK moves to a more ‘light touch’ approach to AI, attracting increased global investment.
Macro risk factors
An inescapable fact is that sterling can suffer bouts of sharp weakness if ‘risk off’ factors emerge. The 2020 Covid pandemic illustrates this, as sterling sold off aggressively in Q1 that year, even though the implications of the pandemic were global. In theory there is no major ‘risk off’ scenario on the horizon, but it is worth being cognizant of a ‘tail risk’ scenario. For example, if the current ‘Artificial intelligence’ boom suffered a correction, a wider market sell off would likely lead to sterling weakness.
Major themes impacting EUR in 2026
The investment case for European assets became significantly more positive in the early part of last year, following the announcement of major fiscal reforms. Sentiment and positioning shifted positively toward the euro, but a tangible impact is more likely in 2026 and 2027, with additional GDP growth forecast at 1.2% in 2026 and 1.4% in 2027.
ECB/Rate policy
The European Central Bank (ECB) have signalled, alongside market expectations, that they have reached the end of their rate cut cycle. This occurs at a time when inflation has reached the 2% target, and longer-term inflation expectations remain slightly skewed to the downside. Despite risk of further disinflation, growth from fiscal expansion will likely keep the ECB from cutting rates further. Cutting rates during fiscal expansion would risk re-igniting inflationary pressures. Really, market sentiment toward the euro should move away from being driven by rate policy and become more focused on economic data, growth, and any risk factors associated with wider macro themes.
Growth
As highlighted previously, the fiscal package announced in 2025 will have tangible benefits to growth in 2026/27. While the eurozone lags behind the US in this area, it is mainly shedding the negative growth story, which had been partly driven by structural issues in Germany, such as low productivity and reliance on cheap Russian energy. Sentiment has turned a corner; the differential between the eurozone and other developed economies should narrow.
Ukraine
Geopolitics remains a key focus in early 2026 as negotiations over Ukraine continue and US involvement remains ongoing. A settlement is possible but unlikely in the near term, given the divergent positions of Ukraine and Russia. Europe’s reduced reliance on Russian energy means that ending the conflict alone would likely have only a modest impact on the euro. Nonetheless, easing geopolitical risk could support euro gains if set against a generally positive macro backdrop.
Other factors
There were periods of political instability last year, particularly in France, which caused some moves in country-specific bond yields. Nonetheless, the euro remained resilient versus other major currencies, supported by stable institutions and credible policy frameworks. Markets continue to monitor political developments, but these are not currently seen as a major downside risk. With the euro market positioning far from extremes, there is scope for long positioning to build if macro or risk sentiment remains supportive.
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