Last quarter, we anticipated that the dollar would strengthen, but what we did not foresee was the extent and speed of the rise. Indeed, during the weeks leading up to the US elections and once the Republican sweep was confirmed, the dollar’s rise was exacerbated. Over the last quarter, the dollar rose 7% against the euro, ending the year at 1.0354.
Although the move has been abrupt and the dollar clearly looks expensive, we continue to believe that most factors are in place for continued strength in the greenback. We also think it is plausible that parity with the euro could be achieved at some point in 2025. Despite uncertainties surrounding the implementation of Trump’s policies, the most probable scenario is that US growth will outperform Europe’s. The situation in the euro area appears unlikely to improve, at least in the short term. Germany has clearly lost its competitive advantage, while France is struggling with the lack of a clear majority in parliament. This is coupled with a stickier inflation environment in the US compared to a declining trend in the euro area. In this context, the Fed is likely to refrain from lowering rates too quickly, whereas the ECB will be forced to lower rates more swiftly. With the interest rate differential set to widen in favour of the US, it seems clear that the dollar is poised to strengthen further.
Of course, there may be a few surprises that could change the dollar’s course, not least Trump’s unpredictability. German elections could have a positive outcome on sentiment and give a boost to the economy, as would the end to the Ukraine war and the reconstruction period that would ensue. However, for the moment, this is not our base case scenario.
Date of report: January 8th 2025