By Chelsey Dulaney

Suddenly, the dollar is back in fashion.

Donald Trump's unexpected win in the U.S. presidential election sent the dollar up 2.4% against a basket of 16 major peers to its biggest weekly gain since May 2015, and analysts say the rally likely has further to go.

Investors expect Mr. Trump's proposals to boost fiscal spending, cut taxes and loosen regulation will bolster economic growth and ultimately prompt the Federal Reserve to step up the pace of short-term interest-rate increases.

That is helping to shake the dollar out of a monthslong slump.

"The strong U.S. growth potential warrants dollar outperformance in the final two months of the year," said Vassili Serebriakov, currency strategist atCrédit Agricole. The French bank is recommending its clients buy the dollar-yen currency pair, forecasting it could strengthen by another 1.2% by the end of the year, after a 3.5% gain last week.

The dollar's rise has come as a surprise to many traders and portfolio managers. Analysts initially expected the dollar to weaken under the promise of a Trump presidency due to protectionist trade policy proposals. As Mr. Trump's victory crystallized on the night of the election, the WSJ Dollar Index measuring the greenback against 16 other currencies fell as much as 0.8%.

But the U.S. currency has since bounced back, rising nearly 2% against major peers to an eight-month high as Mr. Trump outlined expansionary spending proposals.

Investors say the biggest boon for the dollar could be higher U.S. interest rates. Mr. Trump's plans for big fiscal spending are expected to boost inflation and bolster the case for lifting U.S. rates.Fed-funds futures, a popular tool for betting on U.S. interest-rate policy, show investors assign a 81% chance to the Fed raising rates at its meeting next month, according to CME Group data. Higher rates boost the currency by making dollar assets more attractive.

Following a two-year rally in which the dollar rose more than 20% against major peers, many analysts had abandoned calls for further dollar strength this year, citing tepid growth and the risk that a dollar rally would increase market turbulence. Before the election, the WSJ Dollar Index had slipped 2.4% this year as investors accepted that U.S. rates were likely to remain lower for longer.

Now, investors are assigning a 58% chance that the Fed will raise rates at least twice by next November, according to CME Group data.

Many analysts question whether a sustained dollar rally is in the cards, noting that global growth remains soft and that months will pass before investors get a chance to scrutinize a fuller Trump economic package.

Brad Bechtel, a managing director in foreign-exchange trading at Jefferies Group, warns that investors are getting ahead of themselves by driving the dollar up so sharply.

"We're pricing in the effects of his new term right away, but how long before we actually get to implementation?" he said. "The market is overshooting."

Mr. Trump's proposals to renegotiate key trade agreements could also depress stagnant global growth, which could weigh on the U.S. economy and the dollar, said Mr. Bechtel.

"If he starts emphasizing the potential for trade wars...it could completely derail the whole thing," he said.

The dollar has been especially strong against emerging-market currencies. Developing nations often come under pressure when U.S. rates rise as local assets become less attractive to yield-seeking investors. Emerging markets' dollar-denominated debt alsobecomes more expensive to pay back.

Since the election, the U.S. dollar has strengthened 14.2% against the Mexican peso, 8.1% against the Brazilian real and 2.4% against the Indonesian rupiah. Emerging-market stocks and bonds also suffered about $2.4 billion in outflows last week, with much of that cash exiting since the election, according to the Institute for International Finance.

Ugo Lancioni, head of currency management for asset manager Neuberger Berman, says the selloff in emerging-markets assets could eventually upend the dollar's rally.

"If the dollar goes too far, it triggers a selloff in emerging markets and runs the risk that the Fed will be less incentivized to raise rates, " said Mr. Lancioni, who in recent weeks has pared back bets that the dollar will rise.

Fed officials have cited the spillover effect of higher U.S. rates on emerging markets as a reason to proceed cautiously with interest-rate increases.Mr. Lancioni also thinks the dollar could be undercut by the considerable uncertainty over whether Mr. Trump's proposals will be successfully implemented and concerns over a rising U.S. debt load.

"I don't buy into the dollar-strength story," said Mr. Lancioni. "I think the dollar will strengthen for maybe a week, but I don't think this would be justified unless U.S. growth surprised on the upside."

(END) Dow Jones Newswires

November 13, 2016 15:15 ET (20:15 GMT)

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