Why the dollar’s epic rally could have a little further to run

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Subscribe to enjoy similar stories. The U.S. dollar is entering the new year on a high—and most signs point to more strength ahead.

The currency is a key beneficiary of U.S. exceptionalism. The American economy is growing faster than most, with Europe stuck in a manufacturing rut and China struggling to contain the fallout from its property meltdown.

The Federal Reserve’s newfound hesitance to cut interest rates adds to the appeal of holding dollars, while the artificial-intelligence euphoria that has lifted U.S. stocks continues to draw in foreign investors. Many investors expect Donald Trump’s return to the White House to supercharge the U.S.’s appeal.

The dollar is wrapping up its best quarter since 2016 versus a basket of currencies tracked by The Wall Street Journal. It is on course to end the year with gains against every major peer, having risen especially sharply against volatile emerging-market counterparts. As of Monday, the greenback is up about 20% this year against the Mexican peso and nearly 30% against the Brazilian real.

Key drivers next year are likely to be Trump’s policies, analysts say, and the impact those have on inflation and the Federal Reserve’s stance on interest rates. “Where are people investing nowadays? Number one is the U.S.," said Dominic Schnider, head of global foreign exchange at UBS’s wealth-management division. Yet Schnider, like many currency forecasters, doubts the dollar rally can last.

He says investors are overly fixated on the expected growth boost from Trump’s pledges to cut taxes and red tape. They are ignoring many risks, he said, such as potential blowback on the U.S. economy if Trump follows through on threats to impose new tariffs on foreign goods.