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Don’t Sell the US Dollar Yet

December was another strong month for the US dollar supported by attractive relative growth, rising yields, and tariff risks from the incoming Trump administration. Tactically we are now positive on JPY, and turned neutral on CAD, EUR, SEK and GBP.

We anticipate continued US dollar strength into Q1 2025, supported by superior growth, rising yields, and its safe-haven appeal amid Trump’s tariff risks. However, long US dollar is a consensus trade, the Q4 2024 rally was huge, and positions are becoming stretched. A modest, temporary pullback over the next 1–2 months due to profit-taking appears increasingly likely, as the slow, messy reality of the legislative process dampens optimism around some of Trump’s more growth-positive policies. That said, any pullback in the dollar is expected to be temporary and shallow unless there is a material slowdown in the US economy.

Outside the US, we foresee ongoing growth struggles, lower short-end yields, and regional political risks in Europe weighing on both the euro and the Swiss franc. These factors will likely also limit any meaningful gains for the Norwegian krone and Swedish krona. However, much of this pessimism is already priced into the euro and Scandinavian currencies, whereas the British pound has been buoyed by relatively hawkish Bank of England (BoE) policy expectations. There is more room for BoE rate expectations to be revised downward as the economy stagnates and inflation gradually recedes.

Currency Market Commentary January 2025 Fig2

The descent of the New Zealand economy into recession, the dovish tilt of the Reserve Bank of Australia (RBA), and ongoing headwinds to Chinese growth — including US tariff risks — signal further weakness in the Australian and New Zealand dollars. On the upside, the recent selloff in these Antipodean currencies could open the door to a larger relief rally compared to Europe, should US tariffs prove milder than expected or Chinese stimulus turn out to be more robust.

US Dollar (USD)

The US dollar remains the top-ranked currency in our model, supported by strong growth, high yields, and its safe-haven appeal. Trump’s victory reinforces this dynamic for investors, given his focus on deregulation and tax cuts — both the extension of cuts from his previous administration and the prospect of additional new cuts. Meanwhile, growth in the UK, EU, Antipodeans, and China continues to soften. We expect the dollar to remain resilient with an upside bias, as the strong fundamental outlook makes it difficult to sell. However, long dollar is a consensus trade, the Q4 2024 rally was substantial, and positions are becoming stretched. A modest, temporary pullback over the next 1–2 months, driven by profit-taking is increasingly likely even on minor negative US news events.

Our long-term views remain unchanged. We have consistently held that the US dollar is likely to decline by at least 10–15% over a two year horizon, as US yields and growth revert toward the G10 average, and the country grapples with substantial fiscal and current account deficits. If historical patterns hold, any Trump tax cuts likely accelerate the build-up of US debt and points to an even more difficult long run outlook for the US economy, earnings, and the US dollar. For investors with over a two year horizon we strongly recommended short US dollar positions.

Canadian Dollar (CAD)

We hold a neutral tactical view on the Canadian dollar versus the G10 and a modestly negative view against the US dollar. Our models suggest that the Canadian dollar has sold off excessively, particularly given lower interest rates and the recent improvement in economic growth. This presents a potential for a short-term relief rally for the Canadian dollar, perhaps bringing USD/ CAD down to the 1.40–1.41 range. However, over the longer term, strong US fundamentals could push USD/CAD back toward its 2020 highs near 1.47 from current levels around 1.44.

Nevertheless, the Canadian dollar appears more attractive against the broader G10 currencies. The positive spillover effects of US dollar strength, recent improvements in Canadian economic data surprises, and higher oil prices (driven by cold weather) are expected to provide support to the Canadian dollar moving forward.

Euro (EUR)

We shift to a neutral outlook with a slight negative bias on the euro over the tactical horizon relative to the G10 average but expect more pronounced weakness against the US dollar, with the pair likely falling to parity or slightly below. Household balance sheets remain strong, and unemployment is historically low. The recent pickup in services Purchasing Managers’ Index and the moderation of the expected ECB rate cut to 25 bps per meeting are also supportive. However, several factors impede further recovery in the euro, skewing risks to our near-term neutral outlook to the downside.

Current growth remains weak due to significant drag from the manufacturing sector, long run potential growth is anemic, Euro is still on track for rates sub-2% in 2025, and there is no sign of a political path toward much needed economic reforms. Finally, political risk remains high into 2025 due to the lack of clear leadership in France, the German election in February, and policy/tariff risks from the new Trump administration. Not only do we see near-term headwinds our long run fair value model also suggests that euro is expensive versus most of the G10 except the US dollar and Swiss franc.

British Pound (GBP)

We hold a neutral tactical view on the pound relative to the G10 average, with a negative bias. Against the US dollar, we see room for the pound to trade down to 1.20 or slightly below, aligning with our downside expectations for EUR/USD. Strong employment, relatively high yields, solid services PMI, and robust wage growth favor the pound.
However, we maintain a negative bias due to slowing gross domestic product (GDP) growth, the prospect of softer labor markets driven by payroll tax hikes, and the potential for the BoE to deliver more rate cuts than anticipated in 2025. Additionally, the December BoE vote was 6-3 in favor of holding rates steady, with three members voting for a 25 bps cut. This suggests a bias toward easing at the BoE, which could materialize quickly if labor markets and growth weaken further.

Our long-run valuation model presents a more positive outlook for the pound, as the currency appears undervalued relative to fair value. However, we expect sticky inflation and chronically weak potential growth post-Brexit to weigh on fair value, somewhat limiting the pound's upside potential over the coming years.

Japanese Yen (JPY)

We maintain a positive view on the yen against the G10 average, though we continue to expect modest underperformance against the US dollar. The shift higher in expectations for Fed policy rates and lower for the BoJ likely keeps USD/JPY in the 150–160 range. However, with our expectation for 25–50 bps of hikes from the BoJ and 50–75bps of cuts from the Fed in 2025, we see room for USD/JPY to trade down toward 140 by year-end. Additionally, as USD/JPY approaches 160, we see risks of another round of intervention to limit yen weakness. Such action would likely align with the Trump administration’s preference for a weaker US dollar.

Against the G10 excluding US, the picture is more favorable for the yen. Slower growth and greater disinflation outside the US provide room for further yield compression versus the yen. As a result, we expect the severely undervalued yen to outperform the G10 average. The Swiss franc stands out as a particularly attractive short against the yen in the coming quarters. The expected yield differential by April 2025 has collapsed from nearly 2% in the franc’s favor in late 2023 to near zero. The last time it was at that level, CHF/JPY was trading near 120, while it is currently over 170 — a massive misalignment relative to carry.

Swiss Franc (CHF)

We remain negative on the franc over both the tactical and strategic horizons. The currency is the most overvalued G10 currency, based on our estimates of long-run fair value, has the second-lowest yields in the G10 (likely the lowest by March 2025), and core inflation is the lowest in the G10. Meanwhile, the real trade-weighted franc is at the upper end of its 30-year range, and the Swiss National Bank (SNB) is cutting rates. We expect the central bank to become more inclined to intervene directly in currency markets to weaken the franc once the policy rate falls below its current level of 0.50%. In fact, given that a major factor in the inflation undershoot is franc strength via lower import prices, we believe it makes sense for the SNB to shift its focus away from rate cuts and toward a weak currency policy. Overall, we see the franc entering a prolonged reversion toward our estimate of its long-term fair value.

Norwegian Krone (NOK)

Our tactical model signals shifted to negative from neutral relative to the G10 average, as a pullback in local equity market performance was only partially offset by a positive change in our economic surprise indicator. The krone remains historically undervalued relative to our fair value estimates and is supported by steady long-term potential growth and a strong balance sheet. However, in the near term, we expect the krone to remain volatile and struggle to find direction as oil markets contend with easing tensions in the Middle East, risks of increased OPEC+ production, and policy uncertainty in Europe and the US.

Swedish Krona (SEK)

Our tactical krona signal returned to neutral in December, as slightly better economic data more than offset weak local equity market performance. The krona is risk-sensitive, with a high beta to the euro. Uncertainty around the regional EU economic outlook, the potential for bouts of risky asset volatility due to global policy uncertainty, and relatively low yields in Sweden currently limit upside for the krona. However, aggressive easing by the Riksbank supports a more solid growth outlook for next year, as monetary stimulus works through the economy.

The currency remains significantly undervalued relative to its long-run fair value and is cyclically depressed. Once growth starts to pick up and global yields move lower as the Fed and other central banks ramp up monetary easing, the krona will have ample room to recover. As such, while we are neutral for now, we see the potential for a more optimistic outlook later in 2025.

Australian Dollar (AUD)

We hold a neutral view on the Australian dollar with a negative bias. Growth headwinds in China, the lack of definitive fiscal stimulus from Chinese authorities, and the potential for significant US tariffs present obstacles to Australian dollar strength. While Australian rates are among the highest in the G10, lending some support, the dovish tone in the RBA's outlook suggests that this yield support may diminish.

On the positive side, the steep selloff in the Australian dollar during Q4 seems excessive relative to changes in growth and rate expectations. By our estimates, the dollar is oversold, opening the door for a temporary bounce over the next 4–8 weeks, though AUD/USD may need to approach 0.60 before we see a relief rally.

In the long term, the outlook for the Australian dollar remains mixed. It is undervalued relative to the US dollar, British pound, euro, and Swiss franc, with room to appreciate, but it appears expensive against the yen and Scandinavian currencies.

New Zealand Dollar (NZD)

Our tactical model remains negative on the New Zealand dollar. The benefit of New Zealand’s high yield has diminished as the Reserve Bank of New Zealand (RBNZ) eases policy amid strong disinflation and recessionary conditions. Ongoing growth challenges and a weak external balance, with the current account at -6.7% of GDP, continue to weigh on the dollar.

Additionally, risks of a US-China trade war pose further headwinds for the currency, given China’s role as a key trading partner. While we believe the RBNZ’s rate cuts are necessary and beneficial, it will take time for the effects to materialize. Until then, the outlook for the New Zealand dollar remains difficult.
In the long term, our view is mixed. Our long-run fair value estimates suggest that the New Zealand dollar is undervalued against the US dollar and Swiss franc, with room to appreciate, but it is overvalued against the yen and Scandinavian currencies.

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