Analysts expect a continued dollar-centric market where most G10 currencies move in tandem against the dollar, keeping dollar correlations high. However, they are bearish on cross-correlations (e.g., involving Sterling and Euro), anticipating greater divergence between non-dollar currencies, which presents an opportunity for investors.

The EM FX risk appetite index, which has a strong track record of predicting downturns, is at an extreme level, suggesting a correction. However, the model was trained during a dollar-bullish cycle and may be misinterpreting the current pro-cyclical, bearish-dollar environment, potentially making its contrarian signal less reliable this time.

The dollar's decline, particularly in April, was not driven by investors divesting from US assets. Instead, it was caused by investors with large, unhedged dollar exposures belatedly adding hedges. This involves selling dollars in the spot or forward markets, creating downward pressure without actual asset sales.

Despite a popular bearish narrative, the U.S. Dollar has a strong bullish case. The U.S. economy is accelerating while Europe and Japan face stagflation, and record short positioning creates fuel for a squeeze. The argument is that U.S. stocks are essentially levered U.S. dollars, and relative strength will attract capital.

With dollar correlations at elevated levels, finding cheap, clean directional expressions against the dollar is challenging. Sophisticated traders are creating bearish dollar baskets that mix G10 currencies (AUD, NOK) with Emerging Market currencies (HUF, ZAR) to achieve greater pricing efficiency.

J.P. Morgan's 2026 outlook is "Bearish Dollar, Bullish Beta," favoring pro-cyclical and high-yield currencies. They expect the dollar's decline to be smaller and narrower than in 2025 unless US economic data significantly weakens, shifting from the more aggressive bearishness of the previous year.

While the macro environment appears supportive of pro-cyclical currencies, several warning signs could trigger a correction. Notably, the aggressive flattening of the US yield curve (e.g., 5s30s spread breaking below 100bps), even if driven by stronger growth, historically signals caution for high-beta assets and could challenge the current consensus view.

The U.S. dollar's decline is forecast to persist into H1 2026, driven by more than just policy shifts. As U.S. interest rate advantages narrow relative to the rest of the world, hedging costs for foreign investors decrease. This provides a greater incentive for investors to hedge their currency exposure, leading to increased dollar selling.

The Federal Reserve's dovish stance, combined with a resilient global growth outlook, creates a favorable environment for "pro-cyclical" currencies like the Australian Dollar and Norwegian Krone. This "middle of the dollar smile" scenario suggests betting on currencies sensitive to global economic momentum, not just betting against the dollar.