Five U.S. Dollar Themes to Watch

Quentin Fitzsimmons , Portfolio Manager

Each month, our portfolio managers, analysts, and traders conduct an in‑depth review of the full fixed income opportunity set. This article highlights a key theme discussed.

Key insights

  • Interest rate cuts are usually associated with currency depreciation, but this is not always the case with the U.S. dollar.
  • A key factor in determining the value of the dollar is how U.S. growth compares with that of other countries.
  • The U.S. dollar’s status as a safe‑haven asset remains intact.

The U.S. dollar has proved resilient so far this year despite the U.S. economy slowing. During our latest policy meetings, the investment team discussed the dynamics driving the currency. Below, Quentin Fitzsimmons, a portfolio manager and member of the global fixed income investment team, outlines the five key themes that we believe investors should monitor.

1. Interest Rate Cuts Do Not Always Trigger U.S. 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 U.S. dollar. In fact, during the last four U.S. rate‑cutting cycles, the dollar has only weakened on one occasion (see Fig. 1). 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 U.S. Dollar More Than U.S. Growth Itself

The dollar has remained strong this year despite the slowing U.S. economy. This is because the way the U.S. economy performs relative to other countries influences the currency more than U.S. growth per se—and in 2019 so far, European growth has disappointed more than U.S. 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.

3. The U.S. Dollar Remains Attractive From a Carry Perspective

In the developed market space, investors can earn one of the highest carry rates by the U.S. dollar. Even if the Fed’s cuts in July and September are followed by others, the dollar is likely to remain attractive for some time from a carry perspective as U.S. interest rates are so much higher than places such as Japan and Switzerland, where rates are negative. That said, when hedging costs are taken into account, U.S. dollar‑based assets can be less appealing for foreign investors. On the surface, for example, U.S. 10‑year Treasuries appear much more attractive than 10‑year German bunds, but that yield advantage effectively disappears if the cost of hedging dollars back to euros is taken into consideration.

4. Tariffs and Trade Wars Create Currency Volatility, not Direction

The impact of tariffs on currencies is difficult to assess. While protectionism should be supportive of the local economy, an efficient market will simply undo the impact to the terms of trade caused by a tariff, sometimes encouraging the protected country’s currency to actually appreciate. Indeed, this may have been an unintended consequence of President Trump’s strategy. Following a particularly difficult round of tariff negotiations, Chinese authorities recently let the renminbi fall to its weakest level against the dollar in more than a decade but kept its value versus a broad basket of other currencies relatively unchanged. Currencies are increasingly being used as political tools, and as the trade negotiations between the two sides go on, we may not have seen the last of the measures. Against this backdrop, volatility is expected, and perhaps the best way to benefit from this is through the use of currency options.

5. The Dollar’s Safe‑Haven Status Remains Intact

During times of stress, investors flock to the U.S. dollar—a trend that looks unlikely to change anytime soon. The U.S. dollar is where liquidity ends up being trapped in this low-yield environment. This trend is amplified by the inversion of the U.S. Treasury curve as parking cash in money market funds has become much more attractive now. Although the Swiss franc and the Japanese yen have been well bid this year as uncertainty has increased, the U.S. dollar remains king for investors looking for safety. This is unlikely to change.

(Fig. 1) U.S. Dollar Behavior Around Rate Cut Cycles

% Move in the U.S. Dollar Before and After First Rate Cut by the Fed
As of September 13, 2019

Graph: % Move in the U.S. Dollar Before and After First Rate Cut by the Fed As of September 13, 2019


Source: U.S. Dollar Spot Index, analysis by T. Rowe Price.


This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.  

It is not intended for distribution to retail investors in any jurisdiction.