● The U.S. dollar has appreciated significantly since late September,
primarily due to widening interest rate differentials between the U.S. and
other major economies.
● The U.S. economy’s resilience, strong labour market, and consumer
spending contribute to expectations that the Federal Reserve (Fed) will not cut
rates as aggressively as other central banks in 2025.
● Geopolitical uncertainty, potential trade wars, and anticipation of
certain political policies are also fueling demand for the U.S. dollar as a
safe haven.
● The prospect of specific trade policies had a negative impact on
currencies like the Euro, Australian dollar (AUD), and New Zealand dollar
(NZD).
● The Eurozone faces structural challenges and expects multiple rate
cuts by the European Central Bank (ECB) compared to fewer by the Fed.
● There’s a considerable chance EURUSD could decline towards or even
below parity with the U.S. dollar.
● While the rally in the U.S. Dollar Index (DXY) shows signs of
exhaustion, Octa Trader analysts believe the market has already factored in
various potentially negative scenarios related to future trade policy, and the
dollar may be overvalued in the short term.
The U.S. dollar has been appreciating almost relentlessly since the
end of September. In just three and a half months, the Dollar Index (DXY),
which measures the value of the greenback relative to a basket of six major
foreign currencies, including the euro, Japanese yen, British pound, Canadian
dollar, Swedish krona, and Swiss franc, was up more than 10% (from 27 September
low to 13 January high). On 13 January, it breached the critical 110.00 level
and although it has since declined slightly, it remains by far the
best-performing currency among other major currencies this year so far.
‘The
reasons for such an impressive rally are plentiful and diverse, but generally
it all boils down to the widening interest rate differentials between the
United States and other major economies’, says Kar Yong Ang, a financial market analyst
at Octa Broker. Indeed, the Federal Reserve (Fed), the U.S. central bank,
currently maintains its benchmark interest rate in the range of 4.25-4.50%,
which is the second highest level among eight industrialized economies. Most
importantly, however, unlike most other central banks, the Fed is not expected
to cut the rates aggressively in 2025 as the U.S. economy continues to
demonstrate striking resilience, marked by robust labour market data and strong
consumer spending. In addition, geopolitical uncertainty and the risk of trade
wars have fuelled safe-haven demand for the U.S. dollar. In fact, the election
of Donald Trump as the next U.S. president largely served as a catalyst for the
recent rally in the U.S. dollar.
‘It was
always assumed that Donald Trump’s victory in the presidential race would be
bullish for the U.S. dollar as his trade and immigration policies were viewed
as inflationary. Therefore, the market started to price in that outcome well in
advance and the dollar began its ascent one month before the election’, says Kar Yong Ang, a financial
market analyst at Octa Broker. Specifically, Trump has explicitly threatened to
impose trade tariffs on Eurozone
and Canada, which clearly had a bearish impact on their currencies. For
example, the Euro, which has a dominant 58% weight in the DXY, has lost more
than 8% against the U.S. dollar since 25 September 2024. The biggest losers,
however, have been risk-sensitive currencies such as the Australian dollar
(AUD) and the New Zealand dollar (NZD) (see the chart below) both of which
devalued by more than 10%.
Major
Currencies Performance Since October 2024
Source: Octa Broker calculations
To put it simply, the U.S. dollar is rising because of fear that
Trump’s policies might spur inflation at best and trigger an all-out trade war at worst. In addition, the U.S.
economy is outperforming most of its peers so the Fed is highly likely to ease
its monetary policy at a much slower pace compared to other countries. Indeed,
a recent Bloomberg survey forecasts a modest 1% growth for the Euro Area this
year, slightly better than the 0.8% projected for 2024 but well below the
long-term average of 1.4%. It is no surprise that the market continues to
expect three or four 25-basis point rate cuts by the European Central Bank
(ECB) in 2025 compared with just one or two by the Fed over the same
period.
In these circumstances, it is hard to expect EURUSD
to rebound substantially from its recent lows. ‘I think there is more than a 50% chance that EURUSD will decline
towards parity at some point this year and may even temporarily drop below the
1.0000 mark’, comments
Kar Yong Ang, adding that Eurozone faces a number of structural challenges
ranging from high energy costs and deindustrialization to geopolitical tensions
and fiscal instability.
As for the DXY, its rally has started to show some signs of
exhaustion lately. Technically, there is a bearish divergence between the DXY
price and the Relative Strength Index (RSI). Furthermore, fundamentally, a lot
of bullish factors have been already priced in and bulls lack new impulses for
the next move higher. ‘I think the
market has overly priced in all the dollar-related positives and the greenback
actually looks slightly overvalued at this point. I think betting on its continuing appreciation is risky’,says Kar Yong Ang. Indeed, in some respect, the
market has factored in a less likely scenario—i.e., that Donald Trump will
impose blanket tariffs and destabilize global trade.
While such a scenario is certainly possible its probability is
relatively low. For example, Bloomberg reported that the U.S. could take a
measured approach towards tariffs. ‘The
market is forward-looking. Just like it started to price in Trump’s victory
well before the elections, so it may now begin to price out the underlying
bullish expectations and anticipate a downturn in a classical “buy the rumour
sell the news” fashion’, concludes Kar Yong Ang, a financial market analyst
at Octa Broker.
About Octa
Octa is an international broker that
has been providing online trading services worldwide since 2011. It offers
commission-free access to financial markets and a variety of services used by
clients from 180 countries who have opened more than 52 million trading
accounts. To help its clients reach their investment goals, Octa offers free
educational webinars, articles, and analytical tools.
The company is involved in a comprehensive network of charitable
and humanitarian initiatives, including the improvement of educational
infrastructure and short-notice relief projects supporting local communities.
Since its foundation, Octa has won more than 90 awards, including
the ‘Most Reliable Broker Global 2024’ award from Global Forex Awards and the ‘Best Mobile Trading Platform 2024’ award from Global Brand Magazine.