FX Outlook 2027: Seven Key Risks

(MENAFN- ING) AI bust: expect unorthodox FX reactions

The resilience of the AI trade in equities has been tested of late, and a more decisive unwind could become an overarching FX driver next year. We think the impact of a major US tech selloff on currencies would depend on how far it spreads to broader US and global risk assets, whether it heavily threatens financial stability, and how it impacts the inflation backdrop. Crucially, the initial FX reaction may look very different from the medium-term move.

The dollar still retains decent safe-haven appeal by our estimates, having recovered from the 2025“sell America” period. Yet episodes in 2026 where AI concerns hit tech stocks without materially spilling into broader equities were accompanied by some USD underperformance. We think contained US tech-specific weakness would continue to weigh moderately on the dollar next year, with low-yielding haven currencies such as the yen, Swiss franc and euro benefiting the most.

The dynamics would be different if tech losses triggered a broader selloff. In that scenario, we would expect an initial safe-haven boost to the dollar, followed by a larger depreciation as the shock deepens and the Federal Reserve response comes into focus. The greater the threat to financial stability, the stronger the case for the Fed to provide liquidity and prevent a global financial crisis-style credit crunch, ultimately weighing on the dollar. Over the medium term, we would expect JPY, CHF and EUR to outperform, while the Australian dollar, New Zealand dollar and non-European EM currencies would be hit harder, consistent with recent AI-driven selloffs (see chart below).

There is, however, an important inflation caveat. A severe risk-off shock would itself reduce inflation risks through potential job losses, negative wealth effects and tighter credit conditions. But if inflation remains elevated, the Fed may be slower to ease, not least to preserve the safe-haven role of the Treasury market. In that scenario, we think the dollar would outperform for longer, while European currencies would be less insulated than under a more benign inflation backdrop.

Exposure to an AI bust among selected currencies Asian currencies have been excluded due to time-zone mismatch

Source: ING, Refinitiv

"> A new 2022 for inflation

Our baseline assumes contained second-round effects from the energy shock, allowing major European central banks to cut rates towards the end of 2027. Four risks could challenge that view.

Second-round effects may simply take longer to emerge, as a prolonged crisis and higher gas prices erode corporate buffers and feed into food and services inflation. Tighter labour markets could amplify the shock through stronger wage growth, while renewed Middle East escalation could drive another sharp rise in energy prices. Finally, greater fiscal support could cushion the hit to growth, but at the cost of higher medium-term inflation pressures.

In such a scenario, we would expect broad dollar gains. Historically, low-yielders have tended to suffer most when Fed tightening drives global yields higher, but we would be wary of applying that playbook mechanically in 2027. The relative central bank response should be the key differentiator, with those that have tightened less so far retaining more ammunition to defend their currencies.

We still see the Norwegian krone and Swedish krona as particularly vulnerable given their low liquidity and high beta, while AUD could be a standout loser given the Reserve Bank of Australia's limited room to tighten further amid domestic vulnerabilities. EUR and JPY, by contrast, could prove more resilient than in 2022, provided the European Central Bank and Bank of Japan respond swiftly to renewed inflation pressures.

Current central bank rates vs latest peak Source: ING, Macrobond

"> Fiscal takeover: contained, but potentially explosive risk

We've all seen the French bond sell-off unfold over recent months. The heart of the story is one of budget credibility. If investors suspect that a government will not or cannot amend a worrying budget trajectory, then they will demand higher coupons or, in extremis, as in Greece 2010, refuse to buy government debt. France is no Greece and our base case assumes that some modest budget consolidation can keep French spreads contained in 2027. Even if French politicians fail to address investor concerns, the ECB's Transmission Protection Instrument (TPI) backstop can prevent broader contagion.

What about the US? One area of concern is that near 60% of US Treasury issuance is in the form of short-term bill issuance, as well as its large refinancing requirements. What happens if inflation spikes and the US Treasury has to pay ever-higher refinancing rates? Equally, what happens if White House policy again upends the dollar-US Treasury safe-haven correlation as was the case in March/April 2025? As we saw at the time, the breakdown in these correlations can trigger some of the most extreme dollar selling. And the fact that investors are again running low FX hedge ratios on US assets warns of a similar setup to early 2025.

Debt financing overview Source: IMF, ING

"> Watch the EU election calendar!

2027 will be a busy year for eurozone political risk, with markets focused primarily on fiscal implications and the threat of EU political fragmentation. Expect any negative EUR impact to make the Swiss franc a standout outperformer, thanks to its European safe-haven role.

French elections combine both fiscal and EU-wide risks and are likely to matter most. The biggest downside for the euro would come from a surprise victory by Jean-Luc Mélenchon in the April-May presidential election or a lack of a clear majority in potential parliamentary elections over the summer. To a lesser extent, a Marine Le Pen victory could also weigh on sentiment if early signals point to a more confrontational approach towards the EU than already expected.

In Germany, several state elections will be watched for signs of greater government instability or further gains by the Eurosceptic Alternative for Germany (AfD). Markets will focus particularly on the implications for Germany's reform agenda, and by extension the growth outlook.

Italian elections rank third among our political risks. Although scheduled by December, a May-June vote looks increasingly likely. Prime Minister Giorgia Meloni remains favoured to secure another mandate, potentially backed by a broader coalition. Italian asset resilience has relied on Meloni's fiscal discipline, so a surprise victory by the centre-left bloc would, in our view, pose material downside risks to BTPs and the euro.

A busy election calendar for next year Source: ING, average of pollsters

"> Debasement trade strikes back

2025 was the year of dollar debasement, when fears over a captured Fed led to pressure on the dollar against the Swiss franc, while bitcoin and gold went bid. We had a flash of that trade again this August, when Scott Bessent's extension of longer-dated US Treasury buybacks unnerved the bond market and USD/CHF was hit hard.

Were US Treasury yields to rise sharply next year, the theme of 'financial repression' could re-emerge. Here the US Treasury could try to contain Treasury yields by providing regulatory incentives to banks to hold more Treasuries or put pressure on the Fed to intervene. Any suggestion that the Treasury would not be allowing Treasury yields to fully compensate investors for inflation or fiscal risk would see the dollar getting slammed.

USD is an efficient safe-haven, but things can change Source: ING, Refinitiv

"> The end of the carry trade?

Popular carry trade target currencies through 2026 have again been the Turkish lira and the Nigerian naira. On the former, Turkish presidential and parliamentary elections must be held by May 2028 and present some risk that the Central Bank of Turkey may opt to change its policy of a controlled depreciation in the lira. That would come as a big shock to the market. Nigeria looks slightly better positioned after recent reforms to fuel subsidies and in the energy sector.

When looking at the popular funding currencies of the yen, we doubt slightly more aggressive BoJ tightening would be enough to trigger a big short squeeze in the yen. And speculators are actually running net long yen positions today as opposed to the large short yen positions held in summer 2024 – the last time we had a major adjustment in yen positioning.

The biggest driver of a carry trade unwind would probably come through a financial shock. Were any unwind in the AI trade to uncover stresses or imbalances in, for example, the private credit area and lead to financial distress, volatility would surge and value-at-risk considerations could prompt indiscriminate deleveraging. We haven't really seen much financial distress since the Silicon Valley Bank crisis of 2023.

A big carry trade unwind would be yen and Swiss franc positive, while negative for the high-yielding activity currencies.

Geopolitical blowout: more than one front to watch

There are three major fronts to watch in terms of geopolitical tail risks next year. All of these would see the dollar as the big outperformer.

A spillover of Russia's war beyond Ukraine, or a material escalation in cyber and hybrid attacks on European countries, would hit European currencies the hardest. CEE currencies and the Scandinavian bloc would be particularly exposed given their geographical proximity and sensitivity to regional security risks. The Swiss franc and yen would join the dollar in a big rally.

A broader Middle East conflict drawing in additional regional or external powers would mainly hit FX through higher energy prices. Net energy importers would suffer most, particularly currencies where central banks have limited scope for additional tightening to offset the inflationary shock. Here, the dollar would be a clear winner, as other low-yielders would suffer from the energy shock.

A sharp escalation in geopolitical tensions in East Asia would put Asian currencies under heavy pressure, with AUD and NZD also vulnerable as liquid proxies. European currencies would be relatively more insulated from the initial shock. Regional risks could also include US-China trade and technology tensions.

Are geopolitical risks the new normal? Source: ING, Macrobond

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