Here's why the US dollar is 'priced to perfection' and why it could rise further

The US dollar (DX=F, DX-Y.NYB) extended its rebound on Wednesday, adding to its gains after the currency was on track for a one-week low following a report from the Washington Post Monday suggesting President-elect Donald Trump won't commit to an aggressive tariff plan.

But just two days later, CNN reported that Trump might declare a national economic emergency to enact universal tariffs, pushing the dollar even higher as stocks faltered.

The U.S. dollar “is perfectly priced,” Bank of America's global rates and currencies research team, led by foreign exchange analyst Athanasios Vamvakidis, wrote in a note published Wednesday. “The dollar has recovered strongly since the US elections, from an already high level.”

After hitting a low in September, the U.S. dollar index, which measures the value of the dollar against a basket of six foreign currencies, including the euro, Japanese yen, pound sterling, Canadian dollar, Swedish krona and the Swiss franc, increased by almost 9%. Since the elections, it has increased by more than 5%.

“In real terms, our estimates suggest that the dollar ended 2024 at its highest level in 55 years,” Vamvakidis said. “This is the longest dollar uptrend in recent decades, beginning in mid-2011.”

109.16 – (+0.07%)

At 2:38:09 p.m. EST. Open market.

DX-Y.NYB ^GSPC

The currency's price action was largely driven by two main catalysts: the election of Trump and the subsequent Republican victory, as well as the recalibration of future Fed easing in the face of strong economic data.

“American exceptionalism in terms of better economic growth, faster productivity growth, superior stock market performance, and higher returns acts as a collective magnet to attract capital to the United States,” wrote Blake Millard , chief investment officer at Sandbox Financial Partners.

Even data often considered less good, such as continued price pressures, can be positive for the dollar.

Latest example: data released on Tuesday shows that prices paid in the services sector during the month of December reached their highest level in almost two years, suggesting that the fight against inflation is not not yet finished.

As a result, traders reduced their bets on a rate cut, leaving less than a 50% chance the central bank will cut rates before its June meeting, according to the CME FedWatch tool. This possibility spooked the markets, with the three main indices closing sharply lower. The dollar, however, immediately rebounded to end the session higher.

“While the Federal Reserve is expected to cut rates less than most other major central banks, expected interest rate differentials favor the greenback,” Millard wrote. “In addition, tariffs will restrict the flow of goods, leading to a decrease in dollar exports abroad and a reduction in demand for foreign currencies.”

The story continues

And with most economists agreeing that Trump's proposed tariff plans will cause inflation to rise over time, the cycle surrounding dollar bullish sentiment remains intact.

President-elect Donald Trump speaks during a news conference at Mar-a-Lago, Tuesday, Jan. 7, 2025, in Palm Beach, Fla. (AP Photo/Evan Vucci) ASSOCIED PRESS

Of course, some risks remain that could derail the dollar's positive trajectory. And a lot depends on the unknowns of Trump 2.0.

“We expect the dollar to remain strong in the near term thanks to U.S. inflationary policies, particularly tariffs, but to weaken later in the year as these policies weigh heavily on the U.S. economy for that the rest of the world reacts,” BofA’s Vamvakidis and his team wrote. “Political uncertainty exposes our baseline scenario to substantial risks.”

Some strategists believe markets have already overreacted to political rumors that may not even come to fruition.

“I think we have to take everything with a grain of salt,” Tony Roth, chief investment officer at Wilmington Trust, told Yahoo Finance's Catalyst program on Wednesday. “Frankly, I'm a little surprised that the markets are paying so much attention to this kind of 24-hour rumor cycle about what he's going to do with the tariffs.”

But for now, the dollar is trading around a key inflection point, Millard said.

“If the dollar continues its rise for 3-4 months, we should expect that risk assets will remain subject to further pressure and a disorderly situation in the future,” he said, making referring to the historical negative correlation between the US dollar index and domestic stocks.

This is primarily because a strong US dollar can have a negative impact on companies doing business abroad, including slow profit growth amid unfavorable currency translation.

S&P 500 companies with international exposure generated most of the profit growth during the third quarter, according to FactSet data. So a stronger dollar, coupled with widespread tariffs, could cause big problems for stocks.

But “if the dollar stabilizes or collapses from there,” according to Millard, “then the bulls should celebrate.”

Alexandra Canal is a senior reporter at Yahoo Finance. Follow her on X @allie_canal, LinkedIn and email her at [email protected].

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