The US dollar has proved resilient so far this year despite the US economy slowing. During our latest policy meetings, the investment team discussed the dynamics driving the currency. Here are five key themes that we believe investors should monitor.
1. Interest rate cuts do not always trigger US dollar weakness
The Federal Reserve (Fed) cut interest rates in July for the first time since the global financial crisis and followed it up with a second cut in September; some market participants expect a further cut in December. Interest rate cuts are usually associated with currency depreciation, but that has not always been the case for the US dollar. In fact, during the last four US rate‑cutting cycles, the dollar has only weakened on one occasion. With that in mind, going underweight the dollar because the Fed is expected to cut could be a dangerous game. There are many other factors that need to be taken into consideration.
2. Growth differentials influence the US dollar more than US growth itself
The dollar has remained strong this year despite the slowing US economy. This is because the way the US economy performs relative to other countries influences the currency more than US growth per se — and in 2019 so far, European growth has disappointed more than US growth. Italy's economy, for example, stagnated in the second quarter, while the UK experienced a contraction in the three months to June.
Perhaps more importantly, in Germany — Europe's largest economy — the manufacturing sector is suffering a recession as trade tensions weigh on export demand. Unless the differential between the two major economies reverses, it is difficult to see how the dollar can significantly weaken against the euro.
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