UBS: US Dollar Strength a Selling Opportunity, Weakness Set to Return

Despite the US dollar's recent surge to a two-month high, UBS remains steadfast in its view that the currency is headed for a downturn. In a note published Wednesday, the Chief Investment Office of the Swiss bank suggests investors to capitalize on current strength to reduce exposure.

The US Dollar Index (DXY), which measures the greenback against a basket of major currencies, has climbed 3.4% in the past month, reaching its highest point since early August. This recent rally has been fueled by a confluence of factors, including stronger-than-expected economic data from the US, diminishing expectations for aggressive Federal Reserve rate cuts, and rising bets on a second Trump presidency.

Market expectations for Fed easing have indeed moderated, with the CME FedWatch Tool now pricing in a 91% probability of a 25 basis point rate cut at the November meeting, down from expectations of a potential 50 basis point cut just a month ago. The prospect of a Trump victory has further bolstered the dollar, as investors anticipate potential tariff extensions that could exacerbate inflationary pressures and necessitate higher US interest rates.

However, UBS maintains that these factors are unlikely to sustain the dollar's strength in the longer term. The investment bank expects the Fed to proceed with its rate-cutting cycle amid cooling inflation, as evidenced by the recent slowdown in the personal consumption expenditures price index (PCE), the Fed’s preferred inflation gauge.

Furthermore, UBS highlights mounting concerns about the ballooning US federal deficit, a factor they believe will weigh on the dollar regardless of who wins the upcoming presidential election. The prospect of increased tariffs under a potential second Trump administration could further strain the US economy, potentially offsetting any initial dollar strength.

Meanwhile, UBS anticipates a growth rebound in Europe heading into 2025, supporting the euro as the European Central Bank continues to cut rates. Additionally, spillover effects from Chinese stimulus measures and the potential for increased risk appetite after the US election are expected to benefit other G10 currencies, including the euro, British pound, and Australian dollar.

"Investors should consider the potential impact of a depreciating US dollar on their portfolios, and look to hedge dollar assets, switch USD cash and fixed income exposure into other currencies," suggests UBS.