Why the Dollar’s Epic Rally Could Have a Little Further to Run
Key drivers in 2025 are likely to be Trump’s policies and their impact on inflation and the Fed’s stance on rates
The U.S. dollar is entering the new year on a high—and most signs point to more strength ahead.
The currency is a key beneficiary of U.S. exceptionalism. The American economy is growing faster than most, with Europe stuck in a manufacturing rut and China struggling to contain the fallout from its property meltdown.
The Federal Reserve’s newfound hesitance to cut interest rates adds to the appeal of holding dollars, while the artificial-intelligence euphoria that has lifted U.S. stocks continues to draw in foreign investors. Many investors expect Donald Trump’s return to the White House to supercharge the U.S.’s appeal.
The dollar is wrapping up its best quarter since 2016 versus a basket of currencies tracked by The Wall Street Journal. It is on course to end the year with gains against every major peer, having risen especially sharply against volatile emerging-market counterparts. As of Monday, the greenback is up about 20% this year against the Mexican peso and nearly 30% against the Brazilian real.
Key drivers next year are likely to be Trump’s policies, analysts say, and the impact those have on inflation and the Federal Reserve’s stance on interest rates.
“Where are people investing nowadays? Number one is the U.S.,” said Dominic Schnider, head of global foreign exchange at UBS’s wealth-management division.
Yet Schnider, like many currency forecasters, doubts the dollar rally can last. He says investors are overly fixated on the expected growth boost from Trump’s pledges to cut taxes and red tape.
They are ignoring many risks, he said, such as potential blowback on the U.S. economy if Trump follows through on threats to impose new tariffs on foreign goods. U.S. government finances are also shakier than in Trump’s first term, with the federal-budget deficit above 6% of gross domestic product, compared with 3.1% in 2016.
“What Trump promises seems great for investment and returns. But can we finance it?” said Schnider. “That’s where the disappointment happens.”
Schnider expects the dollar to lose steam in the first quarter and to end 2025 down 5% from current levels against the euro and 8% off against the Japanese yen.
Momentum can lead the greenback to diverge from estimates of “fair” value for long periods. The dollar surged in the 1990s. After peaking shortly following the 9/11 attacks and the bursting of the dot-com bubble, it fell for much of the 2000s, before bottoming out in 2008 at the start of the global financial crisis.
Still, the dollar’s elevated level makes further gains more difficult.
“Investors must consider how much ‘U.S. exceptionalism’ is already reflected in market prices,” said Hugh Gimber, global market strategist at J.P. Morgan Asset Management. “The dollar is much stronger today than it was ahead of President Trump’s first term at this stage in 2016.”
Tariffs and Fed caution over rate cuts should boost the dollar in the first months of the year, said Athanasios Vamvakidis, head of G-10 foreign-exchange strategy at Bank of America. But he later expects it to fall, whether Trump can fully implement his agenda or not.
If Trump can push through his full slate of tariffs, tax cuts and immigration changes, inflation is likely to rise more than markets anticipate, Vamvakidis says. That could initially boost the dollar by forcing the Fed to pause rate cuts, or even raise rates again. But this would ultimately slow the economy and weigh on the dollar.
Alternatively, if Trump’s policies ultimately get watered down, so would their potential growth boost, and U.S. outperformance would fade, he says. Here, investors are looking to Trump’s first term for a history lesson.
The dollar rallied after Trump’s 2016 election, peaked just before his inauguration, and then fell 7.5% in 2017, his first year as president. That marked the worst year for the WSJ Dollar Index since 2007.
“The market has tried to price, in a month, the next four years, and Trump has not even started yet,” said Vamvakidis. “The lesson from his first term was that it was not a straight line. In some areas, Trump started aggressive, but there were more pragmatic solutions.”
Another risk is that the storm clouds hanging over foreign economies—the flip side of U.S. exceptionalism—begin to clear.
The euro has tumbled as Europe teeters on the brink of recession and political volatility weighs on its two biggest economies. Even small improvements in the outlook could lift the euro, said Steve Englander, head of G-10 foreign-exchange research at Standard Chartered.
“When was the last time anybody said anything good about Europe? Europe looks weak, but that’s well-known,” he said. “For the euro to go up, all you need is for people to be moderately positively surprised by anything.”