US Dollar Outlook 2025: Will Investors Be Buying or Selling the Greenback?

TradingKey - Foreign exchange (FX) is a massive market. Daily, almost US$7 trillion in FX is traded, making it one of the biggest (and most liquid) markets in the world. Currencies also impact everything from businesses’ margins to trading relationships. In other words, they are impactful. The biggest currency, by far, is the US dollar. 

The US dollar had a blockbuster year in 2024, with the US Dollar Index (DXY) climbing over 7% since October and putting it on track for its biggest annual rally since 2015. Fuelled by Donald Trump’s return to the White House, a resilient US economy, and the Federal Reserve’s measured approach to monetary policy, the greenback has enjoyed a powerful surge. 

But will this strength carry on into 2025, or is the dollar due for a reality check on its gains? The outlook for the dollar is a story of contrasts – opportunities for continued dominance, tempered by mounting risks that could derail its momentum. 

Let’s explore the key factors shaping the greenback’s path forward next year.

Dollar’s stellar year in 2024

Before we look into 2025, here’s a quick recap of the dollar’s performance in 2024, chracterised by a strong rally that reflects confidence in the US economy amid uncertainty abroad. Trump’s tax and spending policies sparked optimism for growth, while weaker economic conditions in Europe and Asia made the greenback a magnet for investors seeking stability. 

Markets also reacted to hints from the Federal Reserve (Fed) that it would proceed cautiously with rate cuts in 2025. Although inflation has cooled significantly, the Fed’s late-year messaging suggested that it’s keeping its options open in case inflationary pressures resurface. 

This perception of a “less dovish” stance helped solidify the dollar’s position as the world’s go-to currency. Meanwhile, Trump’s economic agenda – including tariffs and tax cuts – boosted sentiment among domestic investors. Yet, as the calendar turns to 2025, the sustainability of this rally is increasingly being questioned.

Indeed, among some big Wall Street banks, a lot are predicting US Dollar weakness versus other major currencies in 2025. But what’s driving this thinking?

Big sell-side firms’ projected US Dollar performance versus peers by end-2025

Source: Bloomberg. Forecasts versus spot levels as of 13 December 2024.

What will drive the dollar in 2025?

1. Federal Reserve policy

It’s obviously clear that the Fed remains the most influential player in determining the dollar’s strength. There are two main ways this could play out:

• Cautious cuts: The Fed is expected to reduce rates in 2025, but by how much remains uncertain. If it opts for a measured pace, the dollar could stay resilient, particularly if foreign central banks elsewhere around the world lean more aggressively into easing.
• Aggressive easing: On the flip side, a sharper-than-expected drop in rates could weaken the dollar, making it less attractive compared to currencies backed by higher yields. However, that will likely only happen if there’s a deep recession in the US economy.

Recent data suggest that inflation is proving to be more persistent than anticipated, prompting the market to scale back expectations for aggressive Fed rate cuts in 2025. 

Investors should keep a close eye on the Federal Reserve's actions and statements, as even subtle changes in policy direction or tone could trigger significant market reactions. The next Federal Open Market Committee (FOMC) gathering takes place this week (17-18 December) and we should be on the lookout for any signs of what the Fed says about the path of rates.

2. Fiscal Policy and the Budget Deficit

Meanwhile, president-elect Donald Trump’s fiscal policies are a double-edged sword for the greenback. On one hand, tax cuts and infrastructure spending are likely to stimulate economic activity, providing short-term support for the dollar. 

However, these measures are also expected to balloon the federal deficit, which could weigh on sentiment as the year progresses. The US budget deficit may become a key drag on the dollar by mid-2025, with concerns about long-term sustainability eroding investor confidence. 

It will be interesting to see how Trump’s new Department of Government Efficiency (DOGE) initiative, led by Elon Musk and Vivek Ramaswamy, could help reduce government waste and tackle deficit concerns. While the DOGE initiative is ambitious, its success – or lack thereof – could play a crucial role in shaping market perceptions of the dollar’s stability.

3. Global economic conditions

The dollar’s trajectory is closely tied to the health of the global economy. Again, there are two scenarios that could unfold in 2025 as it relates to global growth:

• US outperformance: If the US economy continues to outpace Europe, Asia, and emerging markets, the dollar could remain strong as global investors flock to dollar-denominated assets.
• Global recovery: Conversely, a synchronised recovery across major economies may reduce demand for the greenback. For instance, a recovery in China’s economy and the potential stabilisation in Europe’s energy markets could shift capital flows away from the dollar.

4. Trade policies and tariffs

This is the big unknown. Trump’s protectionist trade policies are the one big “wildcard” for the dollar. Tariffs on imported goods, while intended to boost domestic manufacturing, could have unintended consequences. 

For example, higher prices for imported inputs like steel and aluminum could jolt costs for US manufacturers, creating a negative supply shock that ultimately dampens economic growth. These policies could undermine the dollar if they strain domestic industries reliant on global supply chains. That said, the greenback may still benefit in the short term if trade tensions fuel uncertainty, prompting investors to seek the safety of US assets.

How this all plays out will depend on what Trump can push through and who in his cabinet will have more sway over policy – trade protectionists or free-market/traditional Wall Street types.

The Path Forward: Will the Dollar Peak or Persist?

The US dollar enters 2025 at a pivotal moment. Its stellar performance in 2024 has set a high bar, but sustaining that momentum will require navigating a minefield of fiscal challenges, global competition, and monetary policy shifts. 

Having said that, the outlook in 2025 for the dollar leans toward a cautious strength, supported by its role as a safe-haven asset amid geopolitical instability and the Fed’s likely measured approach to rate cuts, which could preserve its yield advantage. 

Trump’s economic policies have the potential to either further bolster domestic growth or add to inflation which could keep interest rates higher for longer. Both scenarios could lead to the US Dollar holding up better.

However, risks to this scenario remain: a growing budget deficit could undermine confidence in the greenback, especially if the DOGE initiative fails to deliver meaningful results. 

Additionally, a global economic recovery, particularly in emerging markets and Europe, or more aggressive-than-expected Fed rate cuts, could shift investor focus away from the dollar and weakening it against major peers.