"Extreme" USD Valuation Seen by Bank of America
- Written by: Gary Howes
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Image © Adobe Images
According to a new analysis from Bank of America, the Dollar is "priced to perfection".
If correct, the implication is that the current trend of strength is close to its limits, which can ease pressure on global currencies, including GBP/USD.
"A lot is in the USD price," says Athanasios Vamvakidis, an analyst at Bank of America. "The USD has reached a historically extreme value."
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Looking at the Bank for International Settlement's NEER broad index (nominal effective exchange rate), the USD is the strongest it has been in the last 30 years.
Estimates from the IMF's REER equilibrium model leads Bank of America's FX analysts to a similar conclusion.
"The USD appears overvalued by 18.5%, the most in the last 30 years except when it was overvalued by 19% during the energy shocks from the war in Ukraine in 2022," says Vamvakidis.
The Dollar was 2024's best-performing currency, taking the top spot on the leaderboard, having rallied from October amidst signs of a pickup in U.S. economic growth and inflationary pressures. These expectations have only built in the wake of Donald Trump's victory in the November election.
This has prompted the Federal Reserve to warn it was likely to drastically slow the pace at which it cuts interest rates. In fact, following Tuesday's strong U.S. data releases, the market doesn't expect another cut in the first half of the year.
The result of the repricing is higher U.S. bond yields. Despite this, stock markets remain in fine fettle; demand for U.S. bonds and equities is proving a powerful driver of USD demand.
"The USD has now reached multi-decade highs in nominal and real terms and compared with equilibrium estimates based on multiple methodologies," says Vamvakidis.
The USD rally has pushed Pound-Dollar to nine-month lows at the start of 2025, but any letup in the USD rally can help the exchange rate form a near-term base.
"Although we expect the USD to remain strong in H1, we see USD weakness in H2 this year, with the details of US policies determining the exact path and its timing," says Vamvakidis.
Tailrisks to the outlook include a negative market reaction to Trump's geopolitical agenda.
Remarkably, he has said he wants to make Canada a U.S. state, he wants to annex the Danish territory of Greenland and retake ownership of a slice of Panama.
His strategy of creating confusion and doubts on his tariff strategy is also in full swing, leaving a great deal of uncertainty.
For now, markets are sanguine, and FX is remarkably calm. But, Trump is a man with a surprisingly hawkish agenda which can destabilise markets.
This would only drive the USD to higher overvaluations.
