20 Nov 2023
The impact of rate cuts on the USD will depend on the catalysts behind the Fed’s action, among others
History shows that the USD was generally stronger when the catalyst was a crisis, otherwise its performance was mixed
We believe likely Fed easing will not be problematic for the USD in 2024; we expect modest USD strength ahead
When the catalyst for Fed easing was a crisis, the USD was generally stronger
There is no mechanical link between lower US policy rates and the USD’s path.We look to history as a guide on what the Federal Reserve’s (Fed) easing cycle means for the USD, studying data going back to the 1980s. When Fed rate cuts were prompted by a crisis (e.g. the dot.com bubble in 2001, the 2008 global financial crisis and the COVID-19 pandemic in 2020), the USD was generally stronger (Chart 1). Risk aversion dominated the agenda for FX, rather than yield differentials.
Other catalysts for Fed easing prompt a straight forward USD reaction
When the catalyst is not a crisis, the picture is mixed in terms of what it means for the USD (Chart 2). In 2002, after a year-long pause, the Fed re-started its easing process, one which weakened both the USD and equities. In 2007, before the world was contemplating a global financial crisis, the Fed eased to help the US housing market, and the USD was softer afterwards. But the 2019 easing, described by Fed Chair Powell as a “mid-cycle adjustment” provoked very little USD reaction. That being said, earlier episodes of similar insurance cuts saw the USD hold up well (i.e.1984, 1995, and 1998 – indicated by lines in shades of red in Chart 2). Much depends on the nature of the Fed’s easing and what it could mean for the USD.
We do not expect the USD to be materially affected by expected Fed rate cuts in 2024
Our view of modest USD strength in 2024 is not based on an anticipated calamity,either for the US economy or elsewhere. As such, the impact of Fed easing on the USD falls into the realm of uncertainty, rather than “safe haven” USD bullishness. Rates markets currently price in roughly three 25bp rate cuts in 2024 (Bloomberg, 16 November 2023), probably driven by slower US inflation, rather than collapsing growth.Rate cuts delivered in tandem with slower US inflation would also mean that US real interest rates would probably remain positive, supporting the USD, in our view.Shallow cuts could eventually lead to the US economy regaining momentum, and for the USD to remain supported.
Other central banks may feel emboldened to cut
Another factor to consider is what other central banks are doing before or after the Fed cuts rates, and what is priced in. For example, in Australia, there is little easing priced in for 2024. This will create downside asymmetry for the AUD, if the Reserve Bank of Australia surprises with rate cuts.
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