US Dollar Rally Unlikely to Last, UBS Says, Outlining Implications for Major Currencies

The US dollar has surged to near its highest level of the year, but UBS analysts believe this strength is unlikely to be sustained, citing factors such as expected Fed rate cuts and concerns about the US fiscal deficit. The DXY index, which tracks the US dollar against six major peers, is up around 1.2% in June, leaving it just 0.3% below the 2024 high set in April.

"We believe recent US dollar strength should fade in the coming months," says UBS in a note published on Thursday.

The dollar's recent rally has been driven by a combination of factors, including the Federal Reserve's sustained high interest rates, in contrast to rate cuts by other major central banks, as well as the perception of the dollar as a safe haven amid political uncertainty.

The dollar has gained significantly against the yen this year, breaking above the 160 level and pushing the Japanese currency to its weakest level since 1986. The euro, the largest component of the DXY index, has also fallen more than 3% against the dollar in 2024.

However, UBS expects the dollar's strength to wane in the coming months, as the Fed begins cutting rates in September, a move anticipated by UBS analysts. Additionally, the dollar's elevated valuation and concerns about the US fiscal deficit are likely to exert downward pressure on the currency in the longer term.

"We reiterate our view that the US dollar should weaken over the medium term amid US interest rate cuts and fears about the US fiscal deficit," states UBS.

UBS outlines several implications for other major G10 currencies:

Euro: While the outcome of the French elections adds uncertainty, UBS believes the euro has limited room for further weakness. The bank anticipates a favorable outlook for the euro against the US dollar, driven by a nascent recovery in business sentiment in the eurozone and a rebound in global trade.

Japanese Yen: UBS expects the yen's weakness to persist until later in the year, but cautions against chasing the US dollar rally. While the US-Japan yield differentials remain wide, UBS anticipates a narrowing by year-end as the Fed begins to cut rates.

Swiss Franc: UBS believes the Swiss franc is poised to appreciate further, driven by narrowing yield differentials between Switzerland and the US, as well as Europe. The franc's safe-haven qualities also add to its appeal.

"We recommend investors use periods of near-term dollar strength to reduce exposure to the currency, or to engage in volatility-selling strategies to generate portfolio income," UBS says.