The dollar initially weathered the U.S. government shutdown. However, with the FAA now actively canceling flights, the negative GDP impact is becoming more tangible and less likely to be recovered quickly, increasing downside risk for the currency.

While U.S. fiscal deficits remain high, new tariffs are reducing the trade deficit. This means fewer U.S. dollars are flowing abroad to foreign entities who would typically recycle them into buying U.S. assets like treasuries. This dynamic creates a dollar liquidity crunch, strengthening the dollar.

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.

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.

Even if US inflation remains stubbornly high, the US dollar's potential to appreciate is capped by the Federal Reserve's asymmetric reaction function. The Fed is operating under a risk management framework where it is more inclined to ease on economic weakness than to react hawkishly to firm inflation, limiting terminal rate repricing.

A series of upcoming US policy events, including Fed appointments and defense spending debates, are collectively skewed towards dovish monetary policy implications and a weaker fiscal picture. This creates a coordinated downside risk profile for the US dollar, suggesting potential for weakness is greater than for strength.

Officials at IMF meetings expressed surprise at how little the Trump administration has focused on foreign exchange rates. There is a growing expectation that this could change next year, with a renewed focus on the dollar if the US trade deficit fails to normalize, creating a latent political risk.

The combination of restrictive trade policy, locked-in fiscal spending, and a Federal Reserve prioritizing growth over inflation control creates a durable trend toward a weaker U.S. dollar. This environment also suggests longer-term bond yields will remain elevated.

The US dollar's rally has a natural ceiling because the government shutdown is withholding crucial growth and labor market data. Without this data, markets lack the conviction to push the dollar significantly higher, making the trend self-limiting.