The US dollar has seen a significant increase in value, rising over 7% since October 2024. This rise is largely due to expectations surrounding President-elect Donald Trump's economic policies, which focus on tax cuts, increased spending, and tariffs.
These anticipated measures have led to a less cautious outlook from the Federal Reserve regarding interest rates. Recent economic indicators, including strong performance in US services and retail sales, as well as the first increase in the core consumer price index (CPI) since April 2023, suggest that aggressive rate cuts are not necessary at this time. As a result, the Fed is likely to take a cautious approach to avoid reigniting inflation. While a small rate cut is expected in December, signals indicate that the Fed may keep rates steady into 2025. Fed Chair Jerome Powell has expressed a more hawkish stance, stating that the economy does not require further rate reductions. This shift in tone aligns with the market sentiment favoring a stronger dollar in the face of potential economic challenges.
The imposition of tariffs could have a significant impact on export demand, particularly in regions vulnerable to economic slowdowns. This could lead to more aggressive monetary easing in those areas compared to the US, resulting in wider interest rate differentials. For example, disappointing purchasing managers' index (PMI) readings in the Eurozone have led to expectations of a potential 50 basis point rate cut in January 2025, as European policymakers prioritize growth. This divergence in monetary policy could further increase demand for the US dollar as investors seek higher yields in a relatively stronger US economy. Tariffs also introduce uncertainty that can influence investor behavior. As markets grapple with the potential consequences of trade policies, the US dollar's status as a safe-haven asset may become more pronounced. Historical examples, such as the US-China trade war that began in July 2018, demonstrate how geopolitical tensions can drive demand for the dollar, a trend that persisted until the onset of the Covid-19 pandemic disrupted global markets.
Geopolitical uncertainties are expected to play a significant role in shaping the trajectory of the US dollar in 2025. As the global landscape remains tense, the appeal of the dollar as a safe-haven currency is likely to be reinforced. Investors often turn to the dollar during periods of instability to seek refuge from market volatility. While markets are better prepared to handle the consequences of upcoming tariffs, the potential for retaliatory actions remains a concern, suggesting that geopolitical tensions could escalate before any resolution is reached. The interaction between economic policy and geopolitical dynamics creates a complex environment for the US dollar. As the Federal Reserve adjusts its monetary policy based on domestic economic indicators, external factors such as international trade relations and geopolitical conflicts will also influence the strength of the dollar. The potential for increased tensions could lead to greater volatility in currency markets, further complicating the outlook for the dollar.
Despite the recent strength of the US dollar, technical indicators suggest the possibility of a near-term correction. A bearish divergence observed on the daily relative strength index (RSI) indicates that upward momentum may be weakening. Additionally, a bearish crossover on the daily moving average convergence/divergence (MACD) supports this view, suggesting that the dollar may be due for a pullback. Recent data from the Commodity Futures Trading Commission (CFTC) shows that aggregate US dollar positioning against other G10 currencies is at its highest level since July 2024. This high positioning increases the likelihood of a cooling-off period for the dollar as traders may look to take profits after a sustained rally. Furthermore, historical seasonality trends indicate that the dollar typically weakens towards the end of the year, with a rebound often observed in January. As market participants assess the potential for a correction, the interplay between technical signals and broader economic factors will be crucial in determining the future path of the dollar. Investors will need to remain vigilant, monitoring both domestic economic developments and international geopolitical events that could impact currency valuations.