Text: Zhou Hao, chief economist of Guotai Junan International; Zhan Chunli, analyst of Guotai Junan International

This year's interest rate spread story It will continue, and the US dollar is likely to remain at a high level. In the second half of the year, with the continued deepening of the Fed's interest rate cut and the possible "paper tiger" effect of Trump's new policy, the fluctuations in the US dollar may intensify.

The US dollar index emerged from an epic market at the end of 2024, and the main reason behind it was the "re-inflation" logic brought about by Trump's trading. Entering January 2025, before Trump officially took office as president, the market further pushed the dollar index to strengthen the dollar index due to Trump's trading and US re-inflation expectations, causing the dollar index to break through 110 points. Subsequently, the US dollar index fell due to the uncertainty of Trump's tariffs, and a "roller coaster" market trend emerged with market news. Overall, we believe the US dollar will remain strong in 2025. Specifically, the following three factors have brought about the strength of the US dollar. The first is the expectation of reinflation. The 10-year U.S. Treasury yield broke through the 4.8% point in mid-January and then fell, but remained above 4.5%. The logic behind it is that the market believes that Trump's will bring "re-inflation". In this process, the Fed's path to cut interest rates will become very uncertain, so the US Treasury yields rise, driving the US dollar index to strengthen. The second factor is that the Fed's interest rate cut slowed down, so the interest rate spread between the US dollar and non-US currencies remained high, and the flow of arbitrage transactions to the US dollar led to the strengthening of the US dollar. The third factor is that taking into account Trump's tariffs and the impact of the trade war, it may further suppress the growth of the non-US economy, and such expectations have lowered the performance of non-US currencies.

In the short term, the US dollar index will surge and fluctuate in the first quarter. But from the perspective of the full-year trend, we believe that the US dollar may rise first and then fall. As the second half of the year enters, as the Federal Reserve deepens its interest rate cut and increases certainty, the downward pressure on the US dollar exchange rate will appear. At the same time, for the performance of the US economy, the market will also have a trading logic of "buy expectations and sell facts", which will also lead to downward pressure on the US dollar.

We believe that in 2025, interest rate differences will remain the key to determining the US dollar's high. Since the pandemic, a significant decline in inflation has caused most central banks around the world to shift from previous tightening to easing. Due to the different development cycles of economies, some central banks began to cut interest rates earlier, while some central banks cut interest rates later. But due to the decline in global inflation levels, inflation in more and more economies has fallen to the target range, which means that more and more central bank currencies are turning to easing. In addition to the European Central Bank's continued interest rate cuts in 2025, many central banks in Asia, such as South Korea, Thailand, and Indonesia.West Asia, the interest rate cut cycle has just begun. In comparison, the future path of interest rate cuts in the United States appears to be rugged, which is also reflected in the gradual expansion of the interest rate spread between the US dollar and non-US currencies, which also drives the US dollar to strengthen. Judging from the interest rate spread between 10-year U.S. Treasury and 1-year Euribor, it has shown an upward trend since the beginning of 2024, reaching 210 basis points by February 2025, while the level at the beginning of 2024 was only 50 basis points. At the same time, due to the high interest rates of US Treasury bonds, market funds continue to flow to US dollar assets. Over the past year, foreign investors' holdings of US bonds have shown an accelerated trend. As of the end of November 2024, the total amount of US Treasury bonds held by foreign investors reached US$8.6 trillion. From January to November 2024, the amount of new US Treasury bonds from foreign investors reached US$680 billion. Although the spread of the traditional arbitrage currency, the Japanese yen has narrowed compared to the US dollar, as the yen interest rate is still at a low level, US dollar investment is still the market-led choice. Overall, we believe that the interest rate narrative of US dollar and non-US currencies will continue in 2025. The fundamentals of the US economy will be another core factor that dominates the US dollar trend in 2025. Since the end of last year, the US economic data has continued to be positive. With the support of Trump's tax cuts and other tax cuts, the market generally believes that the US economy may show a "no landing" trend. But in a high interest rate environment, there is still great uncertainty about how the US economy performs. Judging from the experience of the past two years, in the fourth quarter of 2023, when the U.S. Treasury bond interest rate approached 5% in 10 years, the U.S. economy experienced a significant decline, which eventually led to a sharp increase in the market by the end of 2023. Expectations of interest rate cuts in 2024; another case is that in April 2024, when US Treasury interest rates rose sharply again in 10 years, US stocks showed significant weakness. From these two scenarios, high interest rates also mean Achilles' heel for the US economy. Although the good economic performance supports relatively high interest rates, excessive interest rates will be for the macro economy and capital The market has brought negative impacts. Although the market is prone to accepting the "blond girl" effect from the economic level at the beginning, it should also pay attention to the "black swan" from the interest rate end. Overall, big trees will not grow into the sky, and the US economy will not undergo huge changes in the short term due to changes in the president. Therefore, we tend to believe that the blessing from Trump will gradually experience aesthetic fatigue with Trump's taking office. From this perspective, we believe that the first quarter of this year will become the high point of this round of the US dollar index. After Trump lands, the US dollar will weaken due to the fall of boots. On the other hand, the market's excessively high expectations of overheating the US economy will also cool down due to normal economic fluctuations and suppression of high interest rates. It will bring about a decline in the popularity of the US dollar. For emerging market currencies, the first quarter of this year will still face pressure from depreciation and capital outflows, but from historical experience, most emerging economies have experienced many similar rounds of shocks and have accumulated considerable response experience. Similarly, exchange rate depreciation will also bring support for exports, which also means that the economy will show its own dynamic adjustment. Therefore, the concerns about a strong dollar should not be exaggerated. To sum up, we believe that in the short term, the US dollar index will have enough motivation to remain strong under the logic of Trump trading, interest rate spread trading and the continued strengthening of the US economy. The story of interest rate differences will continue throughout 2025, which makes the US dollar likely to remain at a high level. However, as the second half of the year enters, the Fed's interest rate cut continues to deepen, and the possible "paper tiger" effect of Trump's new policy, the volatility of the US dollar may intensify. In the short term, the US dollar index is expected to surge above 110, and in the medium term, it will remain at 104-110 points.