07 Jan 2025

The US Dollar (USD) has experienced a decline for the second consecutive trading session. Last week, I observed that the overall gains of the dollar appeared to be excessive, as the DXY was trading approximately two standard deviations above its assessed fair value, according to short-term rate spreads, as noted by Shaun Osborne, Chief FX Strategist at Scotiabank.

USD dips to remain well supported in the weeks ahead

The current situation continues to exist and may be serving as a limitation on the USD. The upcoming week is expected to reinforce the narrative of US exceptionalism regarding the recent strength of the USD; therefore, the potential for losses may be constrained. Significant calendar events this week include the release of the December FOMC minutes on Wednesday, which may present a somewhat hawkish perspective on the policy hike decision due to a dissenting opinion from one policymaker. Additionally, Friday's NFP data is anticipated to indicate a still robust US labor market.

In early trading, USD losses are increasing, following reports from the Washington Post indicating that President Trump is considering a 'universal tariff' specifically on 'critical imports.' This represents a potential downgrade from the previous pre-election threat of widespread tariffs. The CAD initially performed well in overnight trading but has since been surpassed by the MXN in light of the tariff report. Stock markets have reacted positively to indications that trade risks may be reduced, with share prices of European automakers on the rise.

Adjusting the USD's value to its estimated fair value of 105 would signify a reasonable correction in the DXY's rally anticipated for late 2024 and early 2025, with retracement supports located at 105.95 and 104.85. Favorable yield spreads, USD-positive seasonal trends through the first quarter, and other supportive elements of the Trump 2.0 platform suggest that any dips in the USD will likely find strong support in the coming weeks.