US Dollar Dominates Early 2025, Reaching Two-Year Highs on Robust Economic Data and Policy Divergence
The US dollar has commenced 2025 with a resounding roar, surging to its highest level since late 2022. The US Dollar Index (DXY), a benchmark measuring the greenback against a basket of major currencies, has touched the 110 mark, driven by a combination of robust US economic performance, favorable interest rate differentials, and lingering trade tensions, particularly with China. Analysts at UBS predict this bullish trend to persist through the first half of the year, with the DXY potentially reaching as high as 115.
Several key factors underpin the dollar’s current strength. Strong US economic data, including positive nonfarm payroll figures and purchasing managers’ index readings, have painted a picture of a resilient economy, boosting investor confidence in the greenback. Simultaneously, higher US Treasury yields continue to attract foreign investment, further bolstering the currency’s value. This contrasts sharply with the more subdued economic landscape in other major economies, particularly Europe, where growth remains sluggish.
While China’s economy is expected to expand by 5% year-over-year in the fourth quarter of 2024, ongoing trade tensions with the US, including the threat of further tariffs, are hindering its ability to counter the dollar’s upward trajectory. UBS strategists believe that even stronger-than-expected economic data from China is unlikely to significantly shift investor sentiment away from the dollar in the near term. The looming threat of US tariffs remains a significant overhang on the Chinese economy and a supportive factor for the US dollar.
The divergence in monetary policy between the US Federal Reserve and other central banks is another crucial driver of the dollar’s ascendancy. While the Fed is expected to maintain its current policy rate, other central banks, notably the European Central Bank, are anticipated to further reduce interest rates to stimulate their respective economies. This policy divergence enhances the relative attractiveness of dollar-denominated assets, further contributing to the greenback’s strength. UBS forecasts that the euro will likely trade below parity with the dollar in the coming months, reflecting this divergence.
Trade policy uncertainties, especially concerning US-China relations, are also playing a significant role in bolstering the dollar. Proposals for across-the-board tariffs of up to 10% and targeted tariffs as high as 60% on Chinese imports could exacerbate trade tensions and further enhance the dollar’s safe-haven appeal. According to UBS strategists, the impact of potential tariffs has not yet been fully priced into the dollar’s value, leaving room for further appreciation should these measures be implemented.
This confluence of factors has led UBS to revise its currency forecasts. The bank now projects the EUR/USD pair to fall below parity in early 2025 and the GBP/USD pair to decline below 1.20. Similarly, the USD/CHF forecast has been adjusted to 0.93 for March 2025, up from a previous estimate of 0.89. These forecasts reflect the bank’s expectation of continued dollar strength in the near term, driven by the aforementioned economic, monetary, and geopolitical factors.
Despite the dollar’s current dominance, UBS cautions against extrapolating this strength throughout the entire year. The bank maintains its view that 2025 could be a "story of two halves," with dollar strength characterizing the first half and a potential partial or full reversal occurring in the second half. This outlook is predicated on the dollar’s current valuation, which is considered to be at multi-decade highs and in overvalued territory, as well as elevated investor positioning in the dollar, which could unwind if the underlying supportive factors weaken. However, for the immediate future, the dollar appears poised to continue its reign, fueled by robust US economic performance, policy divergence, and lingering trade uncertainties.
