UBS strategists project that the US dollar will maintain its strength, driven by robust economic activity and tariff concerns affecting other regions. On Monday, the US dollar index (DXY) surged to its highest level since November 2022, trading above the 110 mark, marking a 9% increase since late September.
The dollar's ascent is supported by favorable domestic data, including strong nonfarm payrolls and a positive services sector purchasing managers' index. This has led to a reduced expectation of Federal Reserve rate cuts this year, with rising US yields further bolstering the dollar.
In contrast, Europe faces a less favorable economic outlook, with subdued growth anticipated. While China's growth is expected to accelerate to 5% year-over-year in the fourth quarter, US tariffs pose a significant risk to its economy. Political and economic uncertainties in South Korea, the EU, and the UK have contributed to currency weaknesses in these regions.
UBS highlights potential monetary policy divergence as a key factor that could further strengthen the dollar. While the Fed is projected to cut rates by 50 basis points in the second and third quarters, the European Central Bank may reduce rates by 100 basis points in the first half of the year.
Strategists note that this divergence could lead to significant currency trends and potential overshooting of exchange rates. They warn that the current USD valuation might not fully account for tariff risks. If new tariffs are implemented, the DXY could range between 110 and 115, potentially impacting major currency pairs significantly.
UBS believes that the dollar's strength could reverse in the second half of 2025, despite being currently overvalued. Their revised forecasts for the EUR/USD pair suggest trading at 1.00 in March, 1.02 in June, and 1.06 in December 2025. In China, despite potential tariff increases, the CNY has only partially reflected this risk, with a forecast of USDCNY reaching 7.50 by June.