What will be the next move for the US dollar? Tonight's non-farm payrolls will determine

After a strong rise, what will be the next move for the US dollar? Tonight's US non-farm payroll data is crucial.

The US dollar has accelerated its rise since the fourth quarter of last year. As we enter 2025, investors face a dilemma: on one hand, the factors that drove the dollar's rise in the fourth quarter still exist; on the other hand, due to the significant increase in the fourth quarter, the market generally believes that many favorable factors have already been priced in, and the short interest in the dollar is quite crowded.

In this regard, UBS believes that the US employment data released on Friday could become a key catalyst for the next move of the dollar. UBS economists expect that non-farm payrolls in December will increase by 180,000, higher than the market's general expectation of 160,000.

Analysts at UBS, including Shahab Jalinoos, stated in their latest report that to create a sufficient impact on the dollar, employment growth data below 100,000 or an unemployment rate rising to at least 4.4% is needed:

This scenario would essentially allow the market to fully price in data that supports at least two rate cuts of 25 basis points this year, with a high likelihood of a rate cut in March.

Even in this case, unless accompanied by significant stock market shocks, the report suggests that the spot exchange rate of the dollar is unlikely to fluctuate significantly before Trump's inauguration due to the risks associated with policy announcements.

Despite the divergence in market expectations for the dollar, UBS is bullish on the dollar, believing that Trump's "Maganomics" agenda will provide ongoing support for the dollar and may trigger a follow-on buying sentiment for the dollar.

After a big rise, the dollar faces a directional choice

Driven by Trump's victory, the dollar achieved a rise of 6% to 12% against G10 currencies in the fourth quarter of 2024.

The policy goals of the Trump administration, such as broad tariffs, deregulation, and new fiscal easing policies, have been priced in as favorable for the dollar. Additionally, relatively strong economic data from the US has also supported the dollar's strength, with the yield on the US 10-year Treasury rising from a low of 4.15% on December 6 to nearly 4.70%.

Meanwhile, economic data outside the US remains weak, with poor December PMI data from the Eurozone and the UK, and the Bank of Japan abandoning the widely expected rate hike in December. These factors have increased the dollar's attractiveness.

Entering 2025, forex traders face a dilemma.

On one hand, the factors that drove the dollar's rise in the fourth quarter still exist, including the continued rise in the real yield on the US 10-year Treasury, potential tariff policies from the Trump administration, reduced market expectations for Fed rate cuts, stable performance of the US stock market, and capital inflows.

On the other hand, the market may have already fully priced in the aforementioned favorable factors for the dollar, limiting the potential for future dollar gains. Furthermore, if US data weakens, there remains significant room for Fed rate cuts over the next two years, which could put pressure on the dollar UBS believes that the non-farm data released at this critical moment will be a decisive factor.

UBS remains bullish: Maganomics provides long-term support for the dollar

UBS economists expect that due to seasonal factors and the impact after the storm, non-farm employment in December will increase by 180,000, higher than the market's general expectation of 160,000 and the two-month moving average of 132,000. UBS expects the unemployment rate to remain at 4.2%, with average hourly wages increasing by 0.3% and working hours remaining stable.

UBS stated that if the data meets expectations, the dollar may not experience significant fluctuations in the short term. However, if there is a significant deviation from expectations, it could trigger sharp fluctuations in the dollar:

To create a sufficient shock to the dollar, such as testing 1.0550 for the euro against the dollar or 155.00 for the dollar against the yen, employment growth data below 100,000 or an unemployment rate rising to at least 4.4% is needed—essentially data that would allow the market to fully price in at least two 25 basis point rate cuts this year, with a high likelihood of a rate cut in March. Even in this scenario, unless accompanied by significant stock market shocks, the report suggests that the dollar's spot exchange rate is unlikely to fluctuate significantly before Trump's inauguration due to the risks of policy announcements.

On the other hand, if the market is already concerned about U.S. inflation dynamics, then employment growth data of 220,000 or more would trigger shockwaves, and a drop in the unemployment rate to near 4.0% or an average hourly wage increase exceeding 0.4% would have a similar effect. In this case, the market may attempt to price in the expectation of at most one 25 basis point rate cut by the Federal Reserve this year, and if the "Maganomics" agenda announced after the inauguration is seen as aggressive, this expectation could completely disappear. In this scenario, the euro against the dollar could test new lows of 1.0200, and the dollar against the yen could break through 160.00, leading to greater subsequent volatility if these levels are breached.

UBS also pointed out that from the perspective of traditional position data analysis, the market's negative reaction to soft data (such as sentiment or expectation data) is usually stronger than the positive reaction to hard data (such as GDP or employment data).

However, UBS believes that Trump's "Maganomics" policy agenda provides long-term support for the dollar, while there is a "fear of missing out" (FOMO) mentality in the market to buy dollars. Therefore, contrary to traditional views, the report suggests that the current market is more likely to strengthen the dollar under the impetus of strong data rather than causing a significant decline in the dollar during periods of weak soft data