The Dollar’s Rise to Power: A Story of Fear and Resilience
In a remarkable display of strength, the US dollar has surged over 10% in just three and a half months, breaching the critical 110.00 level and solidifying its position as the best-performing currency among major economies this year.
Interest Rate Differentials: The Key to the Dollar’s Success
According to Kar Yong Ang, a financial market analyst at Octa Broker, the primary driver behind the dollar’s impressive rally is the widening interest rate differentials between the United States and other major economies. The Federal Reserve’s benchmark interest rate, currently ranging from 4.25-4.50%, is the second highest among eight industrialized economies, and unlike most other central banks, it is not expected to cut rates aggressively in 2025.
Geopolitical Uncertainty and Safe-Haven Demand
The election of Donald Trump as the next US president has also played a significant role in the dollar’s ascent. Trump’s trade and immigration policies are viewed as inflationary, leading the market to price in a bullish outcome well in advance. Additionally, geopolitical uncertainty and the risk of trade wars have fueled safe-haven demand for the US dollar.
The Impact on Other Currencies
The euro, which has a dominant 58% weight in the DXY, has lost over 8% against the US dollar since September 2024. Risk-sensitive currencies such as the Australian dollar and the New Zealand dollar have devalued by more than 10%. The market’s fear of Trump’s policies and their potential impact on global trade has led to a decline in these currencies.
The Eurozone’s Structural Challenges
The Eurozone faces a number of structural challenges, including high energy costs, deindustrialization, geopolitical tensions, and fiscal instability. These challenges have led to a modest 1% growth forecast for the Euro Area this year, well below the long-term average of 1.4%. As a result, the European Central Bank is expected to cut rates three or four times in 2025, compared to just one or two by the Fed.
A Bearish Divergence for the DXY
Despite its impressive rally, the DXY is showing signs of exhaustion. Technically, there is a bearish divergence between the DXY price and the Relative Strength Index (RSI). Fundamentally, a lot of bullish factors have been priced in, and bulls lack new impulses for the next move higher.
A Risky Bet on the Dollar’s Continuing Appreciation
Kar Yong Ang believes that the market has overly priced in all the dollar-related positives and that the greenback looks slightly overvalued at this point. Betting on its continuing appreciation is risky, especially considering that the market may begin to price out the underlying bullish expectations and anticipate a downturn.
The Market’s Forward-Looking Nature
The market is forward-looking, and it may now begin to price out the underlying bullish expectations and anticipate a downturn in a classical “buy the rumor sell the news” fashion. As Kar Yong Ang concludes, the probability of Donald Trump imposing blanket tariffs and destabilizing global trade is relatively low, and the market may start to factor in a more realistic scenario.
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