A note from JPM last week argued that the dollar could keep rising, but also that its stretched and further gains are likely limited. It a conundrum, we await the straw hitting the camels back to break this trend.

Summary of the note below, with various factors of influence I'm sure you'll be familiar with. Neverthe;less, a handy collation. I've bolded some things that caught my eye.

1. Divergence in Global Growth and Central Bank Policies

  • The widening gap in global growth has led to significant differences in monetary policies.
  • The U.S. 10-year bond yield gap with key trading partners has reached its highest level since 1994.

2. U.S. Dollar Strength

  • Despite two Federal Reserve rate cuts in 2024, the U.S. dollar appreciated by 7%.
  • The U.S. real broad effective exchange rate (REER) remains near historical highs, indicating sustained strength.

3. Reasons for Dollar Strength

  • Economic Growth Differentials: The U.S. economy grew 2.7% in 2024, outpacing the 1.7% growth of other developed markets, supported by strong productivity, business investment, and a more stable labor market.
  • Monetary Policy Differentials: Limited Fed rate cuts are priced in (44bps for 2025), compared to larger cuts by the ECB (110bps) and rate hikes in Japan (47bps), sustaining the yield gap.
  • Policy Changes: Domestic manufacturing support, tariffs, and deregulation by the new administration could further bolster business growth and the dollar.

4. Long-term Constraints on the Dollar

  • The dollar is historically overvalued (two standard deviations above its 50-year average), suggesting limited room for further appreciation.
  • Structural issues like the U.S. trade deficit (4.2% of GDP in September 2024) could eventually pressure the dollar.

5. Impacts of a Strong Dollar

  • Challenges for U.S.-based investors: Reduced international company performance and higher costs for U.S. exports.
  • Negative impact on U.S. companies with significant international exposure.
  • A strong dollar supports the narrative of 'U.S. exceptionalism' but requires investors to carefully evaluate portfolio risks.

While the dollar's strength may persist in the short term, historical patterns and structural factors indicate eventual downward pressure in the long run.

usd index dxy 09 January 2025 223