Dollar's Trump-Fueled Rally Faces Looming Reality Check
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The dollar's meteoric rise this year, fueled by President-elect Donald Trump's victory and aggressive Fed rate cuts, is poised for a significant reversal in the latter half of 2025, warn strategists from Morgan Stanley to Societe Generale, as reported by Bloomberg.
Despite the greenback's impressive performance in 2024, which saw the Bloomberg Dollar Spot Index surge over 6%, several factors are expected to weigh on the currency's trajectory in the coming year.
"We're driving the price of an asset up to something that is not sustainable over the long-term," says Kit Juckes, head of currency strategy at Societe Generale, to Bloomberg.
The current rally has been driven by investor anticipation of Trump's potential impact on trade policy and the resulting inflationary pressures. These expectations have prompted a shift in funds towards the US, bolstering the dollar.
However, strategists argue that Trump's policies, particularly the threat of renewed tariffs, could ultimately prove detrimental to the US currency.
"If tariffs make steel and aluminum more expensive, that'll be a negative supply shock for the onshore auto industry that use those imported inputs," says Barry Eichengreen, economist at the University of California at Berkeley, to Bloomberg.
The potential for a widening budget deficit and an increase in the US bond term premium also pose significant risks.
"When the Fed does ease considerably and the dollar loses its relative yield/growth advantage, dollar weakness could be outsized," note JPMorgan analysts.
Furthermore, the Fed's pivot towards easing monetary policy, a key driver of the dollar's recent strength, is predicted to reverse course in 2025. This shift, coupled with improving global economic conditions, could further erode the dollar's relative attractiveness.
The options market, while still pricing in some dollar gains for next year, has already begun to trim its bullish forecasts. One-year risk reversals on the Bloomberg dollar benchmark now trade around 1% in favor of calls this week, down from a four-month high just a month ago, signaling waning confidence in the currency's continued appreciation.
"There's some good building blocks for a strong global economy next year," says Sophia Drossos, strategist and economist at Point72 Asset Management, to Bloomberg. This potential for robust global growth outside of the US could further incentivize investors to shift funds out of the dollar.