The US dollar (DX=F, DX-Y.NYB) extended its rebound on Wednesday, adding to gains after the currency was on track for a one-week low following a report from the Washington Post on Monday that suggested President-elect Donald Trump won't commit to an aggressive tariff plan.
But just two days later, CNN reported Trump could declare a national economic emergency to enact universal tariffs, pushing the dollar even higher as equities faltered.
The US dollar "is priced to perfection," Bank of America's global rates and currencies research team, led by FX analyst Athanasios Vamvakidis, wrote in a note published on Wednesday. "The USD has rallied strongly since the US election, from an already high level."
After hitting a September low, the US Dollar Index — which measures the dollar's value relative to a basket of six foreign currencies, including the euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc — has rallied nearly 9%. Since the election, it has climbed by over 5%.
"In real effective terms, our estimates suggest that the USD ended 2024 at a 55-year high," Vamvakidis said. "This has been the longest USD uptrend in recent decades, which started in mid-2011."
The currency's price action has largely been driven by two main catalysts: Trump's election and the subsequent Republican sweep, along with 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 equity market performance, and higher yields all act as a collective magnet for attracting capital to the United States," wrote Blake Millard, director of investments at Sandbox Financial Partners.
Even data that's often viewed as not so good, like sticky pricing pressures, can be positive for the dollar.
The latest example: Data released on Tuesday showed prices paid in the services sector during the month of December jumped to a nearly two-year high, suggesting the inflation fight is not yet finished.
Traders scaled back rate cut bets as a result, placing a less than 50% chance the central bank cuts rates ahead of its June meeting, per the CME FedWatch Tool. That possibility spooked markets, with all three major indexes closing firmly lower. The dollar, though, instantly rebounded to end the session higher.
"With the Federal Reserve expected to cut rates less than most other major central banks, expected interest rate differentials favor the greenback," Millard wrote. "Also, tariffs will restrict the flow of goods leading to fewer dollars going abroad and reducing the demand for foreign currency."
And with most economists in agreement that Trump's proposed tariff plans will lead to higher inflation over time, the cycle surrounding bullish dollar sentiment remains intact.
The dollar's path forward
Of course, certain risks remain that could derail the dollar's positive path. And a lot depends on the unknowns of Trump 2.0.
"We expect the USD to remain strong in the short term on the back of US inflationary policies, and particularly tariffs, but to weaken later in the year, as these policies take a toll on the US economy while the rest of the world responds," BofA's Vamvakidis and his team wrote. "Policy uncertainty makes our baseline subject to substantial risks."
Some strategists believe markets have already overreacted to policy rumors that might not even come to fruition.
"I think we've got to take it all with a grain of salt," Tony Roth, chief investment officer at Wilmington Trust, told Yahoo Finance's Catalyst program on Wednesday. "I'm a little surprised, frankly, that the markets are ascribing as much importance to this sort of 24-hour rumor cycle mill on what he's going to be doing with tariffs."
But for now, the dollar is trading around a key inflection point, Millard said.
"Should the dollar continue its 3 to 4 month ascent higher, expect risk assets to remain under further pressure and a messy tape going forward," he said, referencing the historic negative correlation between the US dollar index and domestic equities.
A main reason for that is a strong US dollar can adversely impact companies that do business overseas, particularly due to slow earnings growth amid unfavorable foreign exchange conversions.
Per FactSet data, S&P 500 companies with international exposure drove the bulk of earnings growth during the third quarter. So a stronger dollar, coupled with blanket tariffs, could spell big trouble for stocks.
But "if the dollar stabilizes or breaks down from here," according to Millard, "then it should be party on for the bulls."
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