On July 31, the Federal Reserve (Fed) cut rates for the first time since 2008. In the immediate aftermath of this cut, the U.S. Dollar strengthened. This move in the Dollar likely reflects that during the press conference, Fed Chair Jay Powell highlighted that the rate cut was more of a policy adjustment, rather than the beginning of a broader easing campaign. This signaled that the Fed may not deliver the three rate cuts that markets have been expecting before year end.
But what does this shift in Fed policy mean for the Dollar going forward? In the short-run, currencies tend to be driven by two things – economic growth differentials and interest rate differentials. On the economic growth front, we are not expecting the same degree of U.S. exceptionalism that was observed in 2018, which should therefore minimize the impact of growth on the Dollar. Turning to interest rates – yes, it is true that the Fed eased policy today while other major developed market (DM) central banks have stayed the course. That said, the European Central Bank (ECB) looks set to cut rates later this year, and the Bank of Japan (BOJ) has continued to highlight their willingness to act. Furthermore, emerging market (EM) central banks have begun to ease policy, or look set to do so in the near future. As such, Fed rate cuts will be matched by rate cuts elsewhere, leaving the current interest rate differential unchanged. For that reason, we expect that the Dollar will remain range bound in the short-to-medium term.
Longer-term, however, we expect the Dollar to weaken. The U.S. runs a chronic current account deficit – in other words, we are a net borrower of dollars from the rest of the world. For that reason, the dollar should gradually depreciate over time. This should act as a tailwind for international investments in U.S.-dollar denominated portfolios, and simultaneously help support earnings at companies that conduct the majority of their business outside of the United States.
In the short-run, rate cuts won’t help or hurt the Dollar
U.S. Dollar index
Source: Federal Reserve, FactSet, J.P. Morgan Asset Management.
Data are as of July 31, 2019.