Investing.com -- The US dollar (USD) has entered 2025 in an impressive manner, with the dollar index (DXY) reaching 110, its highest level since late 2022. According to UBS strategists, the currency's upward momentum, fueled by robust US economic data, is expected to persist through the first half of the year.
UBS points to several factors driving USD strength. Strong nonfarm payroll and purchasing managers’ index data have bolstered US economic sentiment, while higher yields continue to support the greenback.
By contrast, macroeconomic conditions in other major economies remain mixed. Growth in Europe remains subdued, while China, despite a forecasted 5% year-over-year expansion in the fourth quarter of 2024, faces challenges in offsetting USD momentum amid lingering US tariff risks.
“With US tariff risks looming large, stronger activity in China is unlikely to shift investor sentiment and stall the USD rally, in our view,” UBS strategists led by Dominic Schnider said in a note.
“In our view, near-term USD strength is likely to persist in 1H25 with room to overshoot (DXY potentially reaching 115),” they added. Strategists also highlighted that elevated speculative long positions in the dollar hinge on consistently strong US data to sustain appreciation.
The divergence in macroeconomic performance and monetary policy is also a critical driver of the greenback’s strength.
While the US Federal Reserve is expected to maintain its current policy rate, other central banks, particularly in the Eurozone, are likely to cut rates further. This divergence adds to the potential for USD outperformance, with UBS forecasting the euro to trade below parity with the dollar in the coming months.
Moreover, tariff risks remain a key factor. Proposals for universal tariffs as high as 10% and targeted tariffs of up to 60% on Chinese imports could further enhance the dollar’s appeal. “A large part of the USD strength can be attributed to better macro data—thus tariff risks still have room to strengthen the USD in the short term,” strategists explained.
In this light, UBS expects the EUR/USD pair to drop below parity in early 2025, while the GBP/USD is projected to slide below 1.20. The bank also adjusted its USD/CHF forecast to 0.93 for March 2025, up from a previous estimate of 0.89.
Looking ahead, UBS remains cautious about extrapolating USD strength throughout the year.
“We still think that 2025 could be a story of two halves—strength in 1H, and partial or full reversal in 2H,” the strategists commented. “The fact that the USD is trading at multi-decade highs in strongly overvalued territory and that investor positioning is elevated underpin this narrative, in our view.”