The Continued Strength of the Dollar, but Increasing Risk of Correction by 2025
As the policy direction of U.S. President-elect Trump becomes clearer and the Federal Reserve possibly moves to further rate cuts by 2025, Wall Street strategists are turning bearish on the long-term outlook for the dollar. From Morgan Stanley to JPMorgan, several sell-side strategists predict the dollar will peak by mid-2024 and begin to correct in 2025. Société Générale forecasts that the ICE Dollar Index may drop 6% by the end of next year.
Behind the Strong Dollar: Economic Data and Policy Drivers
This year, the dollar has performed exceptionally well, with the dollar spot index rising about 6.3%, set for the largest annual gain since 2015. Following the U.S. elections in November, the dollar surged to multi-year highs. The market broadly anticipates that Trump's tariffs and tax cuts might further boost inflation, complicating the Fed's rate-cutting decisions, which has encouraged substantial capital flows into the U.S.
However, analysts believe that the current dollar rally is "stomach-churning," with prices exceeding long-term sustainable levels. As the market gradually absorbs the potential decline in U.S. real interest rates and improved global risk appetite, the foundation for the strong dollar may become unsustainable.
Pressure on Non-Dollar Currencies and Emerging Bearish Sentiments
The strong dollar has put pressure on non-dollar currencies across the board. The euro fell to a two-year low near parity after the November elections, and the MSCI Emerging Market Currency Index hit a four-month low. According to the latest CFTC data, speculative traders held $24 billion in net long positions in the dollar as of December 10, the highest since May.
Despite the bullish sentiment on the dollar, risks have emerged. Bloomberg's one-year dollar benchmark risk reversal index fell from a four-month high to about 1%, indicating the market’s bullish sentiment on the dollar is stalling, with more traders starting to exercise caution regarding the 2025 outlook.
Historical Trends: Maintaining Dollar Strength is Challenging
Historical trends indicate that the dollar experienced similar movements during Trump's presidency. After Trump's election in 2016, the dollar initially strengthened but recorded its largest annual decline in 2017 due to weakening U.S. economic momentum and accelerated European growth.
The current consensus is that the dollar's retreat in 2025 might not be as severe as in 2017, but Wall Street largely agrees that the dollar may peak in the first half of 2025. This shift is already reflected in the options market, as bets on the dollar's future rise have noticeably cooled.
Looming Concerns Behind the Strong Dollar
Despite the dollar's strong performance in 2023, supported by U.S. economic data and policy expectations, the future outlook over the next two years is starting to turn cautious. Trump's trade policies and the pace of Fed rate cuts may pressure the dollar in 2025, allowing non-dollar currencies to gradually shake off their current weakness. With Wall Street's bearish sentiment rising, the strong dollar may not be sustainable long-term, and the risk of market turbulence warrants attention.
