Despite a 7.6% rally since October, positioning data suggests long-dollar trades are not fully saturated, leaving room for further upside. The Fed’s cautious approach to rate cuts ensures the dollar retains its yield advantage through at least the first half of 2025. This environment supports carry trades, where investors borrow in lower-yielding currencies (such as the yen or euro) to invest in higher-yielding U.S. assets.
Additionally, the resilience of the dollar as a preferred asset class during periods of global uncertainty remains a factor, reinforcing positive carry even as global liquidity expands.
Bearish Risks: Structural Deficits and Global Liquidity Expansion
U.S. Fiscal Deficits and Structural Imbalances
The most significant long-term risk lies in growing U.S. budget and current account deficits. The Congressional Budget Office (CBO) projects federal debt to reach 122% of GDP by the end of 2024, potentially eroding confidence in the dollar as global investors question the sustainability of U.S. economic policies.
Persistently high fiscal deficits have historically weighed on the dollar over extended periods, as rising debt issuance increases the supply of U.S. treasuries. If bond markets begin to demand higher yields to absorb this supply, dollar valuations could suffer, especially if growth slows later in the year.
Global Rate Cuts and Capital Flows
While the Fed signals gradual easing, other central banks are moving more aggressively. This wave of global rate cuts boosts liquidity and could drive capital into emerging markets, particularly in Asia and Latin America, creating competition for dollar-denominated assets in the second half of 2025.
China’s stimulus measures, if successful, could also accelerate capital outflows from the U.S. toward Asian markets. A stronger recovery in emerging economies would limit the dollar’s upside, as investors seek higher returns in faster-growing regions.
Technical Factors and Seasonal Weakness
Technical analysis suggests the dollar may face resistance around the 108.972 level seen in the chart. This level represents a key area of supply from previous market cycles and coincides with earlier attempts to break higher. The steep ascent since October has pushed momentum indicators into overbought territory, increasing the likelihood of a short-term pullback.
Seasonality also plays a role, with historical patterns indicating dollar softness in late Q4 and early Q1, driven by profit-taking and portfolio rebalancing. A temporary retreat under 107.178 cannot be ruled out, especially if economic data shows signs of cooling.
Market Forecast: Strength in Early 2025, Caution Thereafter
Q1 2025: We forecast the DXY to attempt a breakout over 108.972, driven by tariff effects, strong U.S. economic performance, and positive carry trades. The Fed’s reluctance to cut rates aggressively supports this bullish outlook, while weaker growth in Europe and Japan adds to the dollar’s appeal. The implementation of new tariffs typically strengthens the dollar through two channels: reducing import demand and creating inflationary pressures that keep interest rates higher for longer.
If tariffs come into effect by early Q1, as many expect, inflation may rise faster than projected, reinforcing demand for the dollar. In this scenario, building a new support base at 108.972 to 107.178 may create the upside momentum needed to challenge 114.778.
Mid-to-Late 2025: Risks to the dollar’s strength may increase as the Fed ramps up its easing cycle, narrowing interest rate differentials. As global economic growth stabilizes, capital inflows into emerging markets may intensify. This shift is particularly likely if China’s stimulus measures gain traction, as improving Asian growth traditionally draws investment away from dollar assets.
While sharp declines are unlikely, the dollar may stabilize in the 107-108 range by year-end, finding support near current levels. Traders should watch for consolidation around 107.178 to 108.972. Look for strength over 108.972 and weakness under 107.178.
Key Risks to Monitor
- Fed Policy: Faster-than-expected rate cuts could undercut dollar strength.
- Tariff Fallout: Trade policies could disrupt U.S. growth, particularly if retaliatory measures from China are introduced.
- Emerging Market Growth: Higher yields in Asia and Latin America could redirect capital flows away from the U.S. toward faster-growing regions.
More Information in our Economic Calendar.
