The fate of the US dollar, which fluctuated within a range during the first three quarters of 2024, changed dramatically following Donald Trump's re-election as president. In December, the dollar surged to its highest level in over two years against major rival currencies, closing the year with an 8% gain.By July, signs of a weakening labor market had heightened fears that the US economy was headed for a recession. While some market observers argued that the Federal Reserve had delayed too long in easing monetary policy, speculation grew that interest rate cuts would be implemented urgently.

Indeed, Fed officials announced they had shifted their focus to labor market risks as inflation moved closer to the target. This led to the start of easing with a half-point cut in September. Expectations of a dovish Fed had pushed the US dollar to its lowest levels in over a year by late September.

The dollar's rally began in October, as Trump gained ground in election polls, and further strengthened in November following his decisive victory.

Meanwhile, strong economic data from the US dispelled recession fears. In 2024, the US economy grew robustly, unemployment remained at historic lows, and inflation's progress toward the target stalled in the final quarter.

Looking ahead, Trump's proposed policies are expected to widen fiscal deficits and increase inflation, leading to projections that the Fed will slow the pace of rate cuts in 2025. In fact, at its December meeting, Fed officials indicated they had refocused on inflation risks and projected only two quarter-point cuts for 2025, compared to the projections made in September.

In this context, a growing number of analysts predict the US dollar could reach parity with its biggest rival, the euro, in 2025, with some even suggesting it could fall below parity. The primary reasons driving expectations for a stronger dollar include:

Trump's Protectionist Policies

Trump announced before the elections that he was considering imposing a 60% tariff on goods imported from China and tariffs ranging from 10% to 20% on imports from other countries.

Following the election, even before officially taking office, he continued to issue trade threats, warning of a 25% tariff on goods from Mexico and Canada. If implemented, Trump's proposed tariff policies are expected to raise consumer prices and increase inflation.

• A 60% tariff on China: could raise U.S. inflation by 0.7%.

• A 25% tariff on Mexico and Canada: could raise U.S. inflation by 0.6%.

• A 10% tariff on other countries: could raise U.S. inflation by 0.5%.

A More Hawkish Fed

Taking into account the current pause in inflation's decline, the Fed has projected only two quarter-point rate cuts for 2025. Chair Jerome Powell stated they want to see further progress on inflation before acting. If Trump implements his tariff policies and US inflation rises, the Fed may be forced to adopt a more hawkish stance.

Flight to Quality

Potential trade wars with China and higher tariffs on other countries could negatively affect their economies and weaken global risk appetite. This would likely increase flight to quality, strengthening the US dollar against other currencies. Additionally, ongoing geopolitical risks could further boost demand for the dollar as a safe haven.

Downside Risks for the Dollar in 2025

Despite its current strength, the US dollar could face some downside risks in 2025.

There is still uncertainty about which of Trump's policies will be implemented and when. Additionally, the measures China and other countries might take to protect themselves against tariff risks are also factors that need to be considered.

Trump's policies of deregulation, tax cuts, and expectations related to artificial intelligence could increase demand for riskier assets such as equities, including those in Asia.

The anticipated rise in inflation is likely to reduce the real yields on the US dollar, potentially encouraging a shift toward higher-yielding assets. Furthermore, higher inflation could risk curbing US household consumption. If household consumption is not supported by income growth, spending could decline, limiting inflationary pressures. In such a scenario, we might see a more dovish Fed.

Conclusion

In conclusion, as we look ahead from today, the likelihood of a stronger dollar appears high. However, there are still many unresolved uncertainties, which call for staying vigilant.