The dollar’s ascent still have some momentum
The U.S. dollar is poised to enter the new year with considerable momentum, and prevailing indicators suggest that further strength is likely on the horizon. The currency stands as a significant beneficiary of American exceptionalism. The American economy is outpacing many others, while Europe finds itself mired in a manufacturing slump and China grapples with the repercussions of its property crisis.
The Federal Reserve’s recent reluctance to lower interest rates enhances the attractiveness of dollar holdings, while the surge in artificial intelligence enthusiasm that has buoyed U.S. equities persists in attracting foreign investment. A considerable number of investors anticipate that Donald Trump’s potential return to the White House could significantly enhance the attractiveness of the U.S. market. The dollar is concluding its strongest quarter since 2016 against a range of currencies monitored by The Wall Street Journal. The currency is poised to conclude the year with appreciable gains against all significant rivals, having experienced particularly pronounced increases relative to the fluctuating emerging-market currencies. As of Monday, the dollar has appreciated approximately 20% this year relative to the Mexican peso and nearly 30% against the Brazilian real.
Analysts suggest that the primary influences in the coming year will be the policies of Trump and their repercussions on inflation, as well as the Federal Reserve’s approach to interest rates. “In which sectors are individuals currently allocating their investments?” “The foremost position is held by the U.S.,” stated Dominic Schnider, who leads global foreign exchange at UBS’s wealth-management division.
However, Schnider, akin to numerous currency analysts, expresses skepticism regarding the sustainability of the dollar rally. He argues that investors are excessively focused on the anticipated growth acceleration stemming from Trump’s promises to reduce taxes and regulatory burdens. He noted that numerous risks are being overlooked, including the possible repercussions for the U.S. economy should Trump proceed with his threats to implement new tariffs on imported goods. The financial situation of the U.S. government appears more precarious than during Trump’s initial term, as the federal budget deficit now exceeds 6% of gross domestic product, in contrast to 3.1% in 2016.
“The promises made by Trump appear to be highly favorable for investment and potential returns.” “However, is it feasible to secure funding for this?” inquired Schnider. “This is the point at which disappointment arises.” Schnider anticipates a decline in the dollar’s strength during the first quarter, projecting a 5% depreciation against the euro and an 8% drop against the Japanese yen by the end of 2025.
The dollar’s prolonged ascent over the past decade has perplexed numerous professional forecasters, who highlight a significant overvaluation relative to historical norms alongside increasingly expansive U.S. budget and trade deficits. Bank of America posits that the dollar is overvalued by more than 20%, according to an internal model that takes into account variables such as trade and interest-rate differentials. The momentum may cause the dollar to deviate from assessments of its “fair” value for extended durations. The dollar experienced a significant rise during the 1990s. Following a brief surge in the aftermath of the 9/11 attacks and the collapse of the dot-com bubble, it experienced a prolonged decline throughout the 2000s, ultimately reaching its nadir in 2008 with the onset of the global financial crisis.
Nonetheless, the dollar’s high valuation complicates the prospect of additional increases. “Investors should evaluate the extent to which ‘U.S. exceptionalism’ is already incorporated into market valuations,” stated Hugh Gimber, global market strategist at J.P. Morgan Asset Management. “The dollar exhibits significantly greater strength today compared to its position prior to President Trump’s initial term at this point in 2016.”
Athanasios Vamvakidis, head of G-10 foreign-exchange strategy at Bank of America, indicated that tariffs and the Federal Reserve’s cautious stance regarding rate cuts are likely to strengthen the dollar in the early months of the year. However, he subsequently anticipates a decline, reg ardless of Trump’s ability to fully execute his agenda. According to Vamvakidis, should Trump successfully implement his comprehensive agenda of tariffs, tax reductions, and immigration reforms, inflation may increase beyond market expectations. This could potentially strengthen the dollar by compelling the Federal Reserve to halt rate reductions, or possibly even implement an increase in rates once more. However, this would ultimately hinder economic growth and exert pressure on the dollar.
Conversely, should Trump’s policies be diluted, the anticipated growth stimulus would diminish, leading to a decline in U.S. outperformance, he asserts. In this context, investors are examining Trump’s initial term as a case study. The dollar experienced a surge following Trump’s election in 2016, reached its zenith just prior to his inauguration, and subsequently declined by 7.5% in 2017, marking his inaugural year in office. The year in question represented the most significant decline for the WSJ Dollar Index since 2007.
“In a mere month, the market has attempted to account for the next four years, yet Trump has yet to commence,” remarked Vamvakidis. “The takeaway from his initial term was that the trajectory was not linear.” In certain regions, Trump initiated a confrontational approach, yet ultimately embraced more pragmatic solutions. Another risk is that the ominous signs looming over foreign economies—the counterpoint to U.S. exceptionalism—start to dissipate.
The euro has declined sharply as Europe stands on the edge of recession, with political instability exerting pressure on its largest economies. According to Steve Englander, who leads G-10 foreign-exchange research at Standard Chartered, even modest enhancements in the economic outlook could bolster the euro. “When was the last occasion anyone expressed a positive sentiment regarding Europe?” Europe appears to be in a precarious position, a fact that is widely acknowledged,” he remarked. “For the euro to appreciate, it suffices for market participants to experience a modestly positive surprise regarding any relevant development.”
