Will the US Dollar Collapse with the Fed Cutting Rates?

The US Federal Reserve had made the first emergency rate cut since the 2008 financial crisis during the past week, in an attempt to limit the economic impact of the coronavirus epidemic. Although the move was intended to calm financial markets, the result had not been according to expectations. At the same time, the US dollar had started to weaken and many analysts had started to predict a deeper fall. Is that true or not?

Interest rate advantage vanishing

Since 2014, the Dollar had a great advantage against other reserve currencies like Euro or Yen. With interest rates rising in the US, that had stimulated more demand for the US dollar and for US-based assets. Even we look back since the 2008 financial crisis, the DXY or the US dollar index, had been on an upward path, despite massive monetary stimulus from the Fed.

In terms of the performance of the DXY, it jumped from the 70 area in March 2008, above 100 until 2017. Even though the Fed had cut rates three times by 25 basis points in 2019, the dollar index remained relatively stable. We must acknowledge, though, the situation changed during the past week, after a 50 basis point cut, which eroded the interest rate advantage of the US Dollar.

Will this mean the dollar will collapse?

From our point of view, there could be some further room on the downside for the DXY, as the market pressures the Fed to take short-term interest rates towards the zero bound. However, the impact should be limited, due to several important factors.

First, the US Dollar is still the global reserve currency, with more than 60% of the money circulating globally being dollars. That status had not changed in 2008 when rates hit zero and the likelihood of that happening now is very limited.

Secondly, we can’t be sure about the human impact of the coronavirus, but we can sure the global economy will perform well below expectations. During times of economic uncertainty, the US Dollar had proven to be a reliable safe haven.

Don’t forget the US is still the largest economic power and has the largest military in the world. Most of the big companies will see it as a safe place to store funds, even if the worst things will happen. As a result, we think the dollar has limited downside if we consider a time frame that goes beyond the next few months.

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