Investing.com – The US dollar has been on a tear since its late-September 2024 lows, and UBS thinks this near-term strength is likely to persist in the first half of the new year, with room to overshoot.

At 06:15 ET (11:15 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, traded 0.5% lower, but has gained almost 4% over the course of the last year.

Better incoming US data (nonfarm payrolls and purchasing managers’ index)—and with it, US yields moving higher—have provided broad dollar support, analysts at UBS said, in a note.

Economic news elsewhere has been rather mixed, with growth prospects for Europe staying highly subdued. Accelerating growth in China suggests that there is growth outside the US. But with US tariff risks looming large, stronger activity in China is unlikely to shift investor sentiment and stall the USD rally, in our view.

In the near term, there seem to be limited headwinds holding the USD back, the Swiss bank added.

“US exceptionalism has appeared to reassert itself, with US economic data likely to stay strong in the near term and risks to US inflation moving higher again. The latest growth and inflation dynamics have lifted US growth and inflation expectations, which could allow the Fed to stay on hold in 2025.” 

At least in the short run markets are likely to think this way, while other key central banks are likely to cut rates further. 

The potential for monetary policy divergence is a powerful driver, which leads to trending FX markets and the potential for overshooting exchange rates. 

US tariffs are also looming large, weighing on sentiment. The concern on tariffs is that they will have inflationary consequences. Given inflation scarring is still fresh on investors’ minds, it is dominating market narratives.

“That said, we think that a policy rate of 4-4.5% in the US remains restrictive and is a headwind to economic growth and inflation. This is unlikely to change absent hard evidence that productivity is rising in the US, which may happen given developments in AI and associated investment,” the Swiss bank added.

It appears that the market-unfriendly parts of the new Trump agenda (e.g., tariffs, trade tensions, immigration) are easier to implement and more likely to happen before the market-friendly parts (e.g., tax cuts, deregulation). 

“We think a negative impact on US growth is not priced at all in the forex market, which cannot be said for the rest of the world, particularly Europe,” UBS said.

“Hence, we still think that 2025 could be a story of two halves—strength in 1H, and partial or full reversal in 2H. The fact that the USD is trading at multi-decade highs in strongly overvalued territory and that investor positioning (like speculative accounts in the futures market) is elevated underpin this narrative.”