Scotiabank's FX Market Outlook for the End of Q2 2026: Dollar Strength Unlikely to Continue, Fed Easing Cycle Approaching
2026-06-20 02:09:23
As the second quarter of 2026 draws to a close, the global foreign exchange market landscape is undergoing a shift in logic. Driven by the restructuring of expectations for Federal Reserve policy, the US dollar has strengthened in stages, ending the previous trend dominated by geopolitical sentiment. However, considering multiple factors such as the fundamentals of the US economy, the divergence in global central bank policies, and the easing of geopolitical tensions, Scotiabank judges that the current upward momentum of the US dollar is nearing exhaustion, and the medium- to long-term downside risks continue to accumulate. Meanwhile, non-US dollar currencies such as the Canadian dollar, euro, and Australian dollar will exhibit structurally differentiated trends.
The core driver of this round of dollar strength stems from the repricing of market expectations following the June FOMC meeting. After the outbreak of the US-Iran conflict in early March, the foreign exchange market was largely driven by geopolitical risk aversion. However, by the end of the second quarter, differences in monetary policy among central banks replaced sentiment as the core pricing logic for exchange rate movements. Currently, the dollar exchange rate is supported by both hawkish expectations from the Fed and residual geopolitical risks, but its resilience has weakened. With the implementation of the US-Iran peace agreement, the geopolitical risk aversion premium is gradually fading, coupled with growing concerns about the US economic fundamentals, essentially closing off further upside potential for the dollar.
US Dollar Outlook: Short-term gains overextended, medium- to long-term downward pressure becoming apparent.
From a technical and market cycle perspective, the US Dollar Index (DXY) has encountered strong resistance at its current level, which has persisted for a year, and there are currently no new positive catalysts for further gains. Scotiabank maintains its core bearish view on the US dollar. Short-term support from Fed policy pricing and market sentiment has already been exhausted. In the medium to long term, the structural problems of the US's twin deficits in trade and fiscal policy will continue to erode the long-term valuation foundation of the dollar.
Interpreting Federal Reserve Policy: Framework Restructuring Temporarily Halts Aggressive Rate Hikes, Easing Cycle Approaching
The first policy meeting of newly appointed Federal Reserve Chairman Warsh became a key juncture in the current round of expected fluctuations in the US dollar. The meeting maintained the benchmark interest rate unchanged, but the market tended to interpret it hawkishly. Furthermore, the meeting did not release clear short-term policy guidance, only outlining two core directions: firmly anchoring the price stability target, and establishing five special working groups to comprehensively review the Fed's communication mechanisms, balance sheet management, data calculation system, labor productivity, and inflation policy framework. The research results will begin to be disclosed in the fall of 2026 and will conclude at the end of the year.
The market had largely bet on a rate hike at the Federal Reserve's September meeting, with bullish and bearish expectations roughly balanced. However, Scotiabank cautioned that this expectation risked being overestimated. Warsh explicitly stated that he would not prejudge the working group's findings, and a hasty rate hike in September would contradict the policy approach of a comprehensive review. Meanwhile, the Fed's policy decisions will be constrained by multiple variables, including revised employment data, trends in household income, and the impact of technology on the labor market. Furthermore, the political environment surrounding the US midterm elections will limit the Fed's room for aggressive rate hikes. Scotiabank predicts that the Fed's current policy easing cycle will begin in the fourth quarter of 2026, with a 25 basis point rate cut throughout the year, followed by another 25 basis point cut in the first quarter of 2027, ultimately locking in a final policy rate of 3.25%.
The divergence in policy paths among major central banks globally has further amplified the downward pressure on the US dollar. Among the four major developed economies—the European Central Bank, the US, the UK, and Japan—the European Central Bank has initiated a rate hike cycle, while the Bank of Japan will implement its first rate hike since early 2025 in June 2026. Unlike the Federal Reserve's policy wait-and-see approach and framework restructuring, most overseas central banks are focusing on a single inflation target and maintaining a hawkish stance due to the need to prevent a second wave of inflation driven by high energy prices. The trend of narrowing global interest rate differentials will continue, reversing the strong performance of the US dollar since 2022.
US Economic Fundamentals: Weak Growth Hides Multiple Concerns
The weak fundamentals of the US economy are the core issue suppressing the dollar's valuation. Currently, US consumer confidence remains low, and the Atlanta Fed's GDPNow leading indicator predicts a significant economic slowdown in the second half of 2026. Economic growth is highly reliant on investment in AI-related data centers, with traditional growth drivers weakening. Meanwhile, rising mortgage rates continue to impact the housing market, weakening confidence among both developers and homebuyers, leaving the real estate market in a slump and further exacerbating the uncertainty of economic recovery.
Major non-US dollar currencies: Divergence among developed currencies, with ample room for the Canadian dollar to recover.
In the non-US dollar currency sector, the trends of various currencies showed significant divergence. The Canadian dollar continued to be under pressure in the latter half of the second quarter, falling to a new low for the year due to the sharp widening of the US dollar interest rate differential. However, the downside risks of the Canadian dollar have been fully priced in by the market, and the short-term depreciation is more due to external disturbances from sudden changes in the Fed's policy expectations than to a deterioration in the fundamentals of the Canadian economy. Scotiabank's calculation of the Canadian dollar's fair exchange rate is higher than the current market price, and a medium- to long-term recovery is expected. On the policy front, the Bank of Canada maintained its final interest rate at 3.25%, and expects a cumulative rate hike of 75 basis points from the fourth quarter of 2026 to the first quarter of 2027. The marginal recovery of core inflation, the geopolitical premium of commodity prices, and the narrowing of domestic idle capacity provide support for the Bank of Canada to tighten policy. Scotiabank predicts that the USD/CAD will continue to decline, with a target price of 1.33 in the fourth quarter of 2026 and 1.30 in the fourth quarter of 2027.
The euro traded steadily overall, remaining within a range of around 1.15 throughout the year. The pullback after the initial surge above 1.20 was relatively limited, reflecting strong fundamental support. The European Central Bank's hawkish policy, leading other developed central banks globally, has provided a solid valuation floor for the euro, and short-term geopolitical and sentiment disturbances are unlikely to reverse its medium-term stable trend. As for the yen, the exchange rate reaction to the central bank's interest rate hike was muted, reflecting a lack of market confidence in the strength of Japan's anti-inflationary policies. The yen continued its weak performance, and market concerns about official Japanese intervention in the foreign exchange market persist.
The pound's medium- to long-term outlook is solid. Although short-term risks include political turmoil within the UK Labour Party and pressure on the Prime Minister, fundamental support remains strong. While the Bank of England's hawkish stance has softened slightly, it still expects a cumulative 50 basis point rate hike in the second half of 2026. Meanwhile, the implementation of UK fiscal constraints and the mitigation of fiscal risks provide strong support for the pound's performance.
VI. Commodity Currencies: Overall performance was outstanding, with structural opportunities becoming apparent.
Commodity currencies performed strongly. The Australian dollar continued to hit new multi-year highs, completely reversing the downward trend since 2021. The pace of the rise exceeded market expectations, and Scotiabank has slightly raised its forecast for the Australian dollar's future performance.
VII. Overall Market Outlook: The US dollar is weakening again, and non-US currencies are showing divergent trends.
Overall, the global foreign exchange market in the second half of 2026 will enter a pattern of "a weaker dollar and a recovery in the divergence of non-dollar currencies." The approaching easing cycle of the Federal Reserve's policies and the structural weaknesses of the US economy will continue to suppress the dollar's performance; while the pace of central bank policies and regional economic fundamentals will dominate the rotation of currency pairs, making structural trading opportunities the core theme of the foreign exchange market in the second half of the year.
The core driver of this round of dollar strength stems from the repricing of market expectations following the June FOMC meeting. After the outbreak of the US-Iran conflict in early March, the foreign exchange market was largely driven by geopolitical risk aversion. However, by the end of the second quarter, differences in monetary policy among central banks replaced sentiment as the core pricing logic for exchange rate movements. Currently, the dollar exchange rate is supported by both hawkish expectations from the Fed and residual geopolitical risks, but its resilience has weakened. With the implementation of the US-Iran peace agreement, the geopolitical risk aversion premium is gradually fading, coupled with growing concerns about the US economic fundamentals, essentially closing off further upside potential for the dollar.
US Dollar Outlook: Short-term gains overextended, medium- to long-term downward pressure becoming apparent.
From a technical and market cycle perspective, the US Dollar Index (DXY) has encountered strong resistance at its current level, which has persisted for a year, and there are currently no new positive catalysts for further gains. Scotiabank maintains its core bearish view on the US dollar. Short-term support from Fed policy pricing and market sentiment has already been exhausted. In the medium to long term, the structural problems of the US's twin deficits in trade and fiscal policy will continue to erode the long-term valuation foundation of the dollar.
Interpreting Federal Reserve Policy: Framework Restructuring Temporarily Halts Aggressive Rate Hikes, Easing Cycle Approaching
The first policy meeting of newly appointed Federal Reserve Chairman Warsh became a key juncture in the current round of expected fluctuations in the US dollar. The meeting maintained the benchmark interest rate unchanged, but the market tended to interpret it hawkishly. Furthermore, the meeting did not release clear short-term policy guidance, only outlining two core directions: firmly anchoring the price stability target, and establishing five special working groups to comprehensively review the Fed's communication mechanisms, balance sheet management, data calculation system, labor productivity, and inflation policy framework. The research results will begin to be disclosed in the fall of 2026 and will conclude at the end of the year.
The market had largely bet on a rate hike at the Federal Reserve's September meeting, with bullish and bearish expectations roughly balanced. However, Scotiabank cautioned that this expectation risked being overestimated. Warsh explicitly stated that he would not prejudge the working group's findings, and a hasty rate hike in September would contradict the policy approach of a comprehensive review. Meanwhile, the Fed's policy decisions will be constrained by multiple variables, including revised employment data, trends in household income, and the impact of technology on the labor market. Furthermore, the political environment surrounding the US midterm elections will limit the Fed's room for aggressive rate hikes. Scotiabank predicts that the Fed's current policy easing cycle will begin in the fourth quarter of 2026, with a 25 basis point rate cut throughout the year, followed by another 25 basis point cut in the first quarter of 2027, ultimately locking in a final policy rate of 3.25%.
The divergence in policy paths among major central banks globally has further amplified the downward pressure on the US dollar. Among the four major developed economies—the European Central Bank, the US, the UK, and Japan—the European Central Bank has initiated a rate hike cycle, while the Bank of Japan will implement its first rate hike since early 2025 in June 2026. Unlike the Federal Reserve's policy wait-and-see approach and framework restructuring, most overseas central banks are focusing on a single inflation target and maintaining a hawkish stance due to the need to prevent a second wave of inflation driven by high energy prices. The trend of narrowing global interest rate differentials will continue, reversing the strong performance of the US dollar since 2022.
US Economic Fundamentals: Weak Growth Hides Multiple Concerns
The weak fundamentals of the US economy are the core issue suppressing the dollar's valuation. Currently, US consumer confidence remains low, and the Atlanta Fed's GDPNow leading indicator predicts a significant economic slowdown in the second half of 2026. Economic growth is highly reliant on investment in AI-related data centers, with traditional growth drivers weakening. Meanwhile, rising mortgage rates continue to impact the housing market, weakening confidence among both developers and homebuyers, leaving the real estate market in a slump and further exacerbating the uncertainty of economic recovery.
Major non-US dollar currencies: Divergence among developed currencies, with ample room for the Canadian dollar to recover.
In the non-US dollar currency sector, the trends of various currencies showed significant divergence. The Canadian dollar continued to be under pressure in the latter half of the second quarter, falling to a new low for the year due to the sharp widening of the US dollar interest rate differential. However, the downside risks of the Canadian dollar have been fully priced in by the market, and the short-term depreciation is more due to external disturbances from sudden changes in the Fed's policy expectations than to a deterioration in the fundamentals of the Canadian economy. Scotiabank's calculation of the Canadian dollar's fair exchange rate is higher than the current market price, and a medium- to long-term recovery is expected. On the policy front, the Bank of Canada maintained its final interest rate at 3.25%, and expects a cumulative rate hike of 75 basis points from the fourth quarter of 2026 to the first quarter of 2027. The marginal recovery of core inflation, the geopolitical premium of commodity prices, and the narrowing of domestic idle capacity provide support for the Bank of Canada to tighten policy. Scotiabank predicts that the USD/CAD will continue to decline, with a target price of 1.33 in the fourth quarter of 2026 and 1.30 in the fourth quarter of 2027.
The euro traded steadily overall, remaining within a range of around 1.15 throughout the year. The pullback after the initial surge above 1.20 was relatively limited, reflecting strong fundamental support. The European Central Bank's hawkish policy, leading other developed central banks globally, has provided a solid valuation floor for the euro, and short-term geopolitical and sentiment disturbances are unlikely to reverse its medium-term stable trend. As for the yen, the exchange rate reaction to the central bank's interest rate hike was muted, reflecting a lack of market confidence in the strength of Japan's anti-inflationary policies. The yen continued its weak performance, and market concerns about official Japanese intervention in the foreign exchange market persist.
The pound's medium- to long-term outlook is solid. Although short-term risks include political turmoil within the UK Labour Party and pressure on the Prime Minister, fundamental support remains strong. While the Bank of England's hawkish stance has softened slightly, it still expects a cumulative 50 basis point rate hike in the second half of 2026. Meanwhile, the implementation of UK fiscal constraints and the mitigation of fiscal risks provide strong support for the pound's performance.
VI. Commodity Currencies: Overall performance was outstanding, with structural opportunities becoming apparent.
Commodity currencies performed strongly. The Australian dollar continued to hit new multi-year highs, completely reversing the downward trend since 2021. The pace of the rise exceeded market expectations, and Scotiabank has slightly raised its forecast for the Australian dollar's future performance.
VII. Overall Market Outlook: The US dollar is weakening again, and non-US currencies are showing divergent trends.
Overall, the global foreign exchange market in the second half of 2026 will enter a pattern of "a weaker dollar and a recovery in the divergence of non-dollar currencies." The approaching easing cycle of the Federal Reserve's policies and the structural weaknesses of the US economy will continue to suppress the dollar's performance; while the pace of central bank policies and regional economic fundamentals will dominate the rotation of currency pairs, making structural trading opportunities the core theme of the foreign exchange market in the second half of the year.
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