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.”

Investing.com – The US dollar weakened Friday after US President Donald Trump indicated he would call for lower interest rates, while the euro surged after better than expected economic activity data.

At 04:35 ET (09:35 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, traded 0.6% lower to 107.205, down more than 1% this week.

Dollar weakens on Trump comments 

The dollar has headed lower Friday after Trump, speaking online at the World Economic Forum in Davos, Switzerland, said he will call for lower interest rates from the Federal Reserve.

“I’ll demand that interest rates drop immediately,” he said, in a virtual address. “Likewise, they should be dropping all over the world. Interest rates should follow us all over.”

This probably suggests the pressure shouldn’t be felt just yet when the FOMC meets next week, said ING analysts, in a note. “We expect a decision to hold rates steady next week will not be the trigger of another round of USD longs unwinding.”

The US currency has been on the backfoot this week as widely expected tariff announcements from Trump failed to materialise after his inauguration. 

“This seems to feed into the growing sense that Trump is underdelivering on protectionism compared to pre-inauguration remarks, and that ultimately some of those tariff threats may not materialise as long as some concessions are made on trade,” said ING.

Euro gains on PMI data

In Europe, gained 0.8% to 1.0500, boosted by better than expected eurozone activity data for January, as the region returned to growth.

HCOB’s preliminary composite rose to 50.2 in January from December’s 49.6, nudging just above the 50 mark separating growth from contraction.

An index measuring the bloc’s dominant industry dipped to 51.4 from 51.6, but remained above breakeven, while the manufacturing PMI rose to 46.1, from a revised 45.1, still in contraction.

European Central Bank President is set to speak at Davos later in the session, having mentioned the need for gradual rate cuts earlier in the week, ahead of next week’s policy-setting meeting.

“With external uncertainty staying high and the prospects of European Central Bank cuts already factored in, the case for a rebound in the eurozone’s business confidence in the short term is not very compelling. This should ultimately allow the ECB to stick to the plan of taking rates towards 2% this year,” said ING.

traded 0.7% higher to 1.2436, receiving a boost after the January PMI data came in stronger than expected, adding to the hopes of gradual economic recovery.

The S&P Global’s preliminary rose to 50.9 in January from December’s 50.4, remaining in expansion territory.

BOJ meeting looms large

In Asia, traded 0.5% lower to 155.23, after the increased interest rates by 25 basis points earlier Friday, while projecting that inflation will stay supported and close to its annual target in the years ahead. 

The central bank indicated that it plans additional rate hikes if its economic outlook aligns with expectations in the coming months.

traded 0.7% lower to 7.2385, with the Chinese currency helped by the prospects of gradual imposition of US tariffs, with Trump sounding more conciliatory of late.

Investing.com — Donald Trump’s inauguration week began with a relief rally in G10 currencies against the US dollar (USD), driven by a Wall Street Journal report hinting at a potential delay in tariffs.

UBS strategists, citing their short-term valuation model, analyzed the rally, assessing the extent of tariff risk priced into currencies as of the previous Friday, and consequently, the potential for the USD to weaken in the near term.

According to UBS, the most misaligned currencies at the start of the week were the (EUR), (AUD), and (NZD), with fair values (FVs) estimated at approximately 1.0450, 0.6400, and 0.5750 respectively.

While UBS sees the EUR as likely to reach its near-term target, they are more skeptical about a significant rally in commodity currencies such as the AUD and NZD, citing persistent undervaluation and ongoing weakness in China.

The investment bank also maintains that, except for the (CAD), long USD positions are not excessive enough to suggest a major correction for the EUR and (JPY).

“Ultimately, we think USD pullbacks represent buying opportunities,” strategists spearheaded by Vassili Serebriakov said in a note.

As the focus remains on the dollar, UBS notes that the yen is approaching significant event risk with the Bank of Japan (BoJ) meeting scheduled for January 24. Approximately 22 basis points of hikes are already expected, indicating that a 25 basis point increase may not lead to substantial JPY gains, even though it would reinforce the BoJ’s divergence from the global policy easing trend.

UBS’s equity hedge rebalancing model also indicates the possibility of JPY buying at the month’s end.

Regarding the euro, strategists highlighted the currency’s resilience over the past two years, despite weak fundamentals. They attributed this strength to a strong Balance of Payments (BoP) surplus, driven by the return of foreign bond inflows.

However, UBS cautions that these inflows, especially into French debt, could be at risk if French political uncertainties persist and the European Central Bank (ECB) continues to lower rates.

“What we’ve seen so far is some weakening in demand for French debt, particularly from Japanese investors, but overall bond inflows remaining resilient through Nov,” strategists noted.

Looking ahead, they suggest keeping an eye on this sector as the attractiveness of the Eurozone yield environment for global investors may change.