Today, let’s explore the U.S. dollar and its shifting dynamics in 2024. But first, let’s briefly touch on China’s recent real estate stimulus measures. Although China introduced policies aimed at supporting its property sector, the response has been lukewarm. One key tool that remains unused is the issuance of special government bonds, which could fund the purchase of unsold properties, the most immediate and impactful option. The hesitation to issue these bonds stems from concerns about national debt and the potential for a property bubble. While China cannot avoid issuing bonds, the government is cautious about overdoing it and seems to be waiting for the market’s reaction to find the right balance. The timid approach has left markets disappointed. I’ll delve into this more over the weekend, but now, let's focus on the U.S. dollar.
Shifting Expectations for the Dollar
As we’ve seen, the traditional understanding that "lower U.S. interest rates lead to a weaker dollar" has been challenged recently. When U.S. interest rates drop, the dollar typically becomes less attractive due to lower returns, reducing demand and pushing its value down. This was evident in August 2024, when expectations of U.S. rate cuts caused the dollar to weaken sharply. The dollar-won exchange rate, for example, fell to the low 1,300 won range, raising hopes that it might even drop into the 1,200 won range.
However, contrary to expectations, the dollar strengthened again. As of today, the dollar-won exchange rate has surged past 1,370, the yen has bounced back to 150 yen per dollar after briefly falling below 140, and the euro has also weakened. The dollar index has climbed back to 104. What’s going on? Let’s examine this through two key perspectives.
U.S. Economic Slowdown vs. Global Dependencies
First, we need to understand why the U.S. might lower interest rates. Rate cuts are often a response to concerns about a slowing U.S. economy. Traditionally, a weakening U.S. economy would lead to a weaker dollar, as the prospects for growth diminish. However, the global economy is intricately tied to the U.S. in many ways. Emerging markets, in particular, have grown more dependent on the U.S. economy. If the U.S. economy slows, it could trigger a broader slowdown, especially in economies that rely heavily on U.S. demand and investment.
In this sense, the relative strength of other economies matters just as much as the U.S. slowdown. If the U.S. economy is decelerating, but other economies are slowing even faster, the dollar might not weaken as much as expected. In fact, the U.S. might still be seen as the "least bad" option, which could keep demand for the dollar high.
The Resilience of U.S. Asset Markets
Another key factor is the resilience of U.S. financial markets. Over the past decade, the U.S. economy and stock markets have consistently outperformed other regions. Global investors have shown strong interest in U.S. assets, particularly stocks, which has kept U.S. markets well-supported. Even when stock prices dip, they tend to bounce back quickly, especially with the slightest bit of positive news. This reflects the strength and resilience of U.S. asset markets.
Recently, strong retail sales data boosted optimism about the U.S. economy, with the Atlanta Fed’s GDPNow model projecting 3.4% growth for the third quarter of 2024. This has raised questions about whether aggressive rate cuts are even necessary and whether inflation might become a concern again. In such a scenario, the typical expectation that rate cuts weaken the dollar doesn’t hold up because rate cuts can actually increase the appeal of U.S. assets, attracting global investors and strengthening the dollar.
The Paradox of Rate Cuts and Dollar Strength
This leads us to an interesting paradox: what happens when U.S. rate cuts, instead of weakening the dollar, actually boost demand for U.S. assets like real estate and stocks? In that case, more global capital flows into the U.S., which increases demand for the dollar and strengthens its value. This is particularly true in a world where investors see the U.S. as a safer bet compared to other economies. The more this pattern repeats, the more investors are likely to conclude that “the U.S. is still the best option,” reinforcing the cycle of dollar strength.
This dynamic is unique to the U.S., a phenomenon often referred to as "U.S. exceptionalism." As the Federal Reserve continues to normalize rates after a period of tight monetary policy, these moves could paradoxically fuel even more demand for U.S. assets, pushing the dollar higher rather than weakening it as conventional wisdom would suggest.
Europe and the Diverging Path of the Euro
Meanwhile, Europe is taking a different approach. The European Central Bank (ECB) recently cut interest rates in an attempt to combat slowing growth. Although the U.S. and eurozone show significant differences in growth forecasts for 2024, this gap is expected to narrow in 2025. As U.S. growth slows and Europe starts to recover, some expected the euro to strengthen while the dollar weakened. However, the eurozone’s recovery has been weaker than anticipated, and the ECB’s rate cuts have instead further weakened the euro.
Unlike the U.S., where rate cuts can paradoxically strengthen the dollar, Europe’s rate cuts have led to a drop in the euro’s value, reflecting the challenges facing the eurozone's economy. This divergence underscores the differing impacts of rate cuts in the U.S. and Europe, highlighting the unique position of the U.S. in global markets.
The Return of the "Trump Trade"
There’s also renewed speculation about the so-called “Trump trade” as Donald Trump gains momentum in the 2024 U.S. presidential race. Initially, when President Biden hinted at stepping down, there was hope for a shift in political momentum, but now many are starting to believe Trump might have a stronger chance of winning. Markets are increasingly pricing in the possibility of a Trump victory, which could mean higher interest rates, a stronger U.S. economy, and a return to his protectionist policies.
In this scenario, the U.S. economy could strengthen while other economies face greater challenges, further widening the gap and reinforcing the dollar’s strength. While Trump’s policies might not always lead to dollar strength directly, they could add to the current bullish sentiment surrounding the dollar. I’ll explore this in more detail in future discussions, but it’s clear that the possibility of Trump’s return is contributing to the current trend of a stronger dollar.
Rethinking the Conventional Wisdom
The traditional assumption that “lower U.S. interest rates lead to a weaker dollar” is being put to the test. While this holds in textbook scenarios, real-world dynamics are proving far more complex. As the U.S. continues to demonstrate exceptional resilience, even during periods of monetary easing, it’s becoming clear that the dollar can remain strong despite rate cuts. This is what drives the idea of “U.S. exceptionalism.”
However, no trend lasts forever. Even the seemingly invincible dollar will eventually face challenges as global economic conditions shift. While the U.S. is currently benefitting from its unique position, it’s important to remember that the dollar’s strength isn’t guaranteed indefinitely. Investors and policymakers alike will need to watch closely for signs of change.