Dollar’s Resurgence Reaches Two-Year Highs, But UBS Advises Caution Against Buying
The US dollar has experienced a remarkable resurgence in recent months, climbing to two-year highs after hitting lows just two months prior. This impressive rebound has been fueled by a confluence of factors, including robust US economic data, growing concerns about global economic growth, and the re-election of President Donald Trump, which diminished expectations of significant US interest rate cuts. Market analysts attribute the dollar’s strength to the relative outperformance of the US economy compared to other regions, coupled with global GDP growth uncertainties, ongoing US tariff threats, and the expectation that US yields will remain "higher for longer." While these factors suggest the dollar’s strength could persist into 2025, strategists at UBS caution against viewing this as a clear buy signal for investors.
UBS argues that the dollar’s recent 6% rally from its September low, roughly equivalent to one standard deviation, has already priced in much of the positive news supporting the currency. They believe that chasing further dollar appreciation at this point carries significant risk. The strategists point to the dollar’s "extraordinarily rich valuation in trade-weighted terms" as a key indicator of its unsustainable current level. This overvaluation, they contend, makes the dollar more susceptible to a correction rather than further gains. Instead of adding to long dollar positions, UBS recommends a contrarian approach, suggesting that investors consider selling the dollar on any further price spikes.
This contrarian strategy involves favoring currencies that are expected to benefit from diverging monetary policies. UBS specifically highlights the Japanese yen and the Swiss franc as potential beneficiaries. Within Europe, the British pound stands out as UBS’s top pick, bolstered by improving UK growth prospects and attractive yields. Emerging market currencies also present selective opportunities, with the South African rand, the Indian rupee, and the Indonesian rupiah identified by UBS as attractive for total returns. However, the bank acknowledges that trade risks remain a concern for export-oriented currencies like the Chinese yuan and the Korean won.
UBS’s contrarian stance stems from their belief that the dollar’s current strength is not fundamentally justified and is likely to reverse in the medium term. They project a 6% decline in the broad DXY index, a measure of the dollar’s value against a basket of other major currencies, over the medium term. This anticipated decline is predicated on the expectation of easing US yields and the diminishing positive impact of President Trump’s initial economic policies. The bank’s outlook suggests a shift in the global economic landscape, potentially leading to a more balanced currency market.
The divergence in monetary policies between the US and other major economies plays a crucial role in UBS’s currency outlook. As the US Federal Reserve potentially eases its monetary policy stance in the future, other central banks may maintain or even tighten their policies, creating relative value opportunities for currencies like the yen, franc, and pound. Furthermore, UBS’s focus on emerging market currencies reflects their belief that select economies offer attractive investment prospects despite lingering trade risks. The bank’s analysis suggests a nuanced approach to currency investing, emphasizing careful selection and a contrarian perspective.
In summary, while the US dollar’s recent surge to two-year highs appears impressive, UBS advises investors against complacency. They argue that the current strength is overextended and unsustainable, advocating for a contrarian strategy that favors other currencies poised to benefit from diverging monetary policies and improving economic fundamentals. The bank’s medium-term outlook anticipates a dollar decline, driven by easing US yields and the waning impact of Trump’s economic policies. This perspective underscores the importance of a forward-looking approach to currency investing, considering not only current market conditions but also anticipated future trends.
