UBS Warns Dollar's 2024 Strength Could Soon Crumble

UBS has issued a bearish outlook for the US dollar, signaling a critical shift in the currency's trajectory post the upcoming FOMC meeting. According to the firm's analysis, the dollar's strength, which has been a defining feature of 2024, could be undermined by a combination of economic and policy developments.

The US dollar has appreciated 7% in 2024, with the dollar index (DXY) and the real broad effective exchange rate (REER) both reaching near all-time highs. This strength has been driven by robust US economic growth, which is projected to outpace that of other developed markets. The US economy is expected to expand by 2.7% in 2024, compared to 1.7% for developed markets, supported by strong productivity gains and favorable labor market conditions. These fundamentals have kept US inflation elevated above 2%, potentially delaying anticipated Fed rate cuts and supporting the dollar.

However, the Federal Open Market Committee (FOMC) meeting outcomes suggest a more nuanced path. According to FOMC projections, the median forecast for real GDP growth in 2025 is 1.7%, with a central tendency range of 1.5–1.9%. These projections indicate a slowdown from the previous year's performance but still place the US ahead of its developed market peers. The unemployment rate is expected to remain relatively stable, with the median forecast at 4.4% for 2025, suggesting that labor market conditions are unlikely to prompt immediate rate cuts.

The FOMC's assessment of appropriate monetary policy also points to a gradual normalization of interest rates. The median projected federal funds rate at the end of 2025 is 3.9%, with a central tendency range of 3.9–4.4%. These projections imply that the Fed is not inclined toward aggressive rate cuts in the near term. The divergence in global monetary policy, particularly the ECB's anticipated 110bps of cuts and Japan's rate hikes, further supports the dollar's relative strength.

Despite these near-term bullish factors, UBS cautions that the dollar's current strength is not without vulnerabilities. The US dollar is currently trading at two standard deviations above its 50-year average, historically indicating a high likelihood of a correction. Additionally, the US's persistent trade deficit, which stands at 4.2% of GDP as of September 2024, presents a structural challenge that could eventually weigh on the currency.

The implications of a potential dollar downturn are significant for global investors. A weaker dollar could negatively impact US-based investors in international companies and US firms with substantial overseas operations. Conversely, it could benefit emerging market equities and commodities, which are often dollar-denominated. For the crypto market, a dovish FOMC decision, particularly a larger-than-expected rate cut, is likely to be bullish. Rate cuts typically lead to increased liquidity and a weaker dollar, making risk assets like cryptocurrencies more attractive.

Financial analyst Suliman Mulhem has emphasized the potential for a 50-basis-point rate cut at the upcoming FOMC meeting, arguing that a 25-basis-point reduction would be insufficient to address the current weakness in the labor market. Such a cut, even if fully priced in by the market, would still be bullish for risk assets if accompanied by a dovish tone from Fed Chair Jerome Powell.

UBS's analysis also considers the potential impact of policy changes. The upcoming administration's focus on boosting domestic manufacturing and increasing tariffs could further sustain higher interest rates, supporting the dollar. However, any measures aimed at challenging the dollar's trade dominance or reserve currency status could lead to policy adjustments that undermine the currency.

In conclusion, while the US dollar has been resilient in 2024, UBS warns of a potential bearish shift post the FOMC meeting. The combination of a strong US economy, cautious Fed policy, and structural challenges like the trade deficit creates a complex environment. A dovish FOMC decision, particularly a larger-than-expected rate cut, could catalyze a significant shift in the dollar's trajectory, with positive implications for risk assets like cryptocurrencies and emerging market equities.