February 24, 2025

QuickTakes

Dollar Still Dominant

Despite Recent Weakness

The DXY Dollar Index has fallen 3.0% since it peaked on January 13. Weaker-than-expected consumer spending and sentiment as well as gains in foreign currencies have weighed on the dollar. DeepSeek might also have contributed to the recent weakness of the dollar. But despite some near-term selling, the DXY is still up 3.0% since the November 5 election (chart). It also remains at one of its highest levels of the past decade plus. We think the dollar will remain relatively strong.

Consider some of the recent drivers of the dollar:

(1) “Going Global” to Europe. Global stock investors have been rebalancing their portfolios by reducing their exposure to the US because valuation multiples are lower overseas than in the US. Since the start of this year, the US MSCI’s market-cap share of the World MSCI has edged down to 73.5%, while the Europe MSCI’s share has edged up to 15.7%. The former has been on an uptrend since 2010. We think it should resume its climb during the second half of this year.

(2) “Going Global” to China. In recent months, the Chinese government has implemented various measures to stimulate the Chinese economy and boost stock prices. Then in late January, DeepSeek, a Chinese AI startup company, announced that it had developed a powerful AI model much more cheaply than US companies have done so far. That caused global stock investors to lighten up on the Magnificent-7, while piling into Chinese technology companies, especially those working on AI (chart).

(3) Economic soft patch. Part of the dollar's recent weakness has been due to softer US economic data. The Citigroup Economic Surprise Index (CESI) has fallen the deepest into negative territory that it's been since Q3-2024, when fears started to grow over rising unemployment (chart).

Along with the fall in the CESI, the 10-year Treasury bond yield has dropped from its January 13 peak of 4.8% to below 4.4%. But we don't expect a revisit of last year's lows, mostly because we don't expect the CESI to remain negative for much longer once February data are released. That should keep the 10-year yield in our expected range of 4.25%-4.75% and keep the DXY above 100.

(4) Japanese strength. Foreign currencies have also driven some of the move in the dollar. For instance, the yen has gained 4.8% against the dollar since January 13 to its strongest level since last year's presidential election (chart).

Yen strength has been driven by solid Japanese fundamentals. GDP crushed expectations in Q4, rising 0.7% q/q and 2.8% y/y (saar). Inflation has also been rising. Japan’s core CPI increased 3.2% y/y in January, a 1.5-year high. Expectations for additional BOJ rate hikes have driven the 10-year Japanese government bond yield to a multi-decade record high of 1.42% (chart). Rising yields have increased the attractiveness of Japanese bonds relative to international counterparts.

(5) Gold still glittering. Gold of course has outshined most currencies, its price up 11% ytd and hitting another new record high today (chart). We expect it to breach $3,000 per ounce in short order. Since Russia invaded Ukraine and the US froze Russia's currency reserves, the central banks of Russia, China, and Iran along with others have been adding more gold to their international reserves.

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