What level is the US dollar at after the "epic surge"?

Bank of America believes that after a recent surge, both the nominal and real effective exchange rates of the US dollar have reached decades-high levels, being significantly overvalued among G10 currencies. Looking ahead to this year, the dollar exchange rate may exhibit a "strong first, weak later" divergence, with the specific path and timing depending on the details of US policy.

In a research report on January 8, Bank of America analysts stated that the current cycle of dollar appreciation began in mid-2011, marking the longest period of dollar appreciation in recent decades.

Since the US elections last year, the dollar exchange rate has further strengthened from its high. Strong data following significant interest rate cuts in September triggered a reassessment of Federal Reserve policy expectations, along with the Republican Party's overwhelming victory, jointly driving the appreciation of the dollar. By the end of last year, the real effective exchange rate (REER) of the dollar was at a 55-year high, while the nominal effective exchange rate (NEER) also reached its strongest level in 30 years.

Currently, the dollar is significantly overvalued. The International Monetary Fund's REER equilibrium model shows that the dollar is overvalued by 18.5%, a level of overvaluation that is nearly the highest in the past thirty years, second only to the 19% overvaluation during the 2022 energy crisis. Bank of America's internal BEER (Behavioral Equilibrium Exchange Rate) model estimates that the degree of overvaluation of the dollar even reaches 26%, far exceeding the 22% overvaluation level in 2022, marking the highest point in the past thirty years.

From the perspective of G10 currencies' REER, the degree of overvaluation of the dollar is also very significant. According to the 20-year average deviation of REER, the IMF's REER model, and Merrill's BEER model, the dollar is the most overvalued currency. The Swiss franc follows closely, while the Japanese yen and Nordic currencies (such as the Norwegian krone and Swedish krona) are the most undervalued. Even based solely on the average of the past ten years, the degree of overvaluation of the dollar remains the most prominent.

Looking ahead to 2025, Bank of America believes the dollar exchange rate may exhibit a "strong first, weak later" trend. In the short term, driven by US inflation policies (especially tariff policies), the dollar will remain strong, but as these policies harm the US economy and other regions respond accordingly, the dollar is expected to weaken later this year