The US dollar is poised for a promising start to 2025, buoyed by a confluence of supportive factors. Strong domestic fundamentals, a relatively-hawkish Fed, optimism surrounding Donald Trump’s electoral victory, and a weak economic backdrop in the rest of the world should underpin incremental gains. 

But the honeymoon is unlikely to last. The delayed impact of the Fed’s aggressive post-pandemic tightening is already hitting housing market activity, and labour markets are cooling. After a long period of surprisingly strong growth, consumer demand seems likely to slow, and heightened policy uncertainty stemming from Trump’s unpredictable agenda could erode business confidence, weakening US asset price outperformance. By mid-year, projections for the Fed’s policy path should begin ratcheting lower, sapping the dollar’s appeal.

Fed expectations could shift in a more dovish direction.
Market expectations for change in central bank policy rate from March 2024
As at December 10

A tilt toward protectionism in the US could also lead to more fiscal stimulus in China and the euro area. This could reinvigorate global growth, narrow expected growth differentials, and redirect capital flows away from dollar-denominated assets.

Economic surprise differentials could turn less positive.
Economic surprise indices, four-week moving average
January 2021 – December 2024

Foreign exchange markets—currently crowded into bets on a continuation in the ‘US exceptionalism’ theme—are vulnerable to a correction, and to a secular rise in volatility. An era of unchecked dollar gains may be nearing its end.