In this round of Fed rate cuts, how will the US dollar perform? Global policy coordination is key

As the Fed's rate cut approaches, the global economy faces increased uncertainty, with the market paying close attention to the future trend of the US dollar.

A recent research report released by Goldman Sachs pointed out that historical data shows that the performance of the US dollar during the Fed's rate cut cycle is not fixed, but is influenced by the policies and economic conditions of other major economies around the world.

Goldman Sachs divided the rate cut cycles from 1995 to 2020 into "coordinated" and "uncoordinated" categories, finding that coordinated rate cut cycles are usually more favorable to the US dollar, while uncoordinated cycles are unfavorable to the US dollar.

In the past three months, several G10 central banks have begun to loosen monetary policy. Goldman Sachs believes that this could create a relatively coordinated global rate cut cycle, thereby helping to alleviate the downward pressure on the US dollar from the Fed's rate cut.

Diverse historical performance, no fixed pattern for the US dollar

Goldman Sachs' analysis shows that in the seven Fed rate cut cycles since 1995, the performance of the US dollar has not followed a unified pattern. In some cycles, the US dollar performed strongly, while in others, it appeared weak.

The traditional theory of the US dollar's "smile curve" suggests that the US dollar performs well in two extreme scenarios: when the global economy is very weak (the US dollar strengthens as a safe-haven currency), or when the US economy is performing very well (capital flows into US assets).

However, Goldman Sachs believes that despite the US dollar's safe-haven status, in the case of a slowdown in US economic growth, the performance of the US dollar depends on the conditions of other global economies. If the growth of other economies remains robust, the US dollar may not strengthen due to US economic issues.

Goldman Sachs uses the example of the US dollar's trend from the end of 2007 to the beginning of 2008:

At the end of 2007 to the beginning of 2008, the US economy slowed down, but the US dollar weakened. This was because at that time, the economic growth in other regions of the world was relatively strong, and the market believed that the US economic issues were mainly domestic and had not spread to other regions.

Global policy coordination is key, US dollar performance varies with the situation

Goldman Sachs classified each rate cut cycle from 1995 to 2020 as "coordinated" or "uncoordinated", meaning that if at least four other G10 central banks began cutting rates within 6 months of the Fed, the cycle is considered coordinated. Otherwise, it is considered uncoordinated.

The report particularly emphasizes the importance of global G10 central bank policy coordination. Goldman Sachs stated: In coordinated rate cut cycles, the US dollar often outperforms other G10 currencies; while in uncoordinated cycles, the US dollar may relatively weaken.

In the past three months, several G10 central banks have successively loosened monetary policy, and the market expects the Fed to accelerate its shift to an accommodative policy in the near future. Currently, the market's expectation for a 25 basis point rate cut by the Fed next week has strengthened, while the expectation for a significant rate cut has weakened. However, more and more traders are preparing for a 150 basis point rate cut in January next year.

Goldman Sachs points out that other central banks may continue to ease policy after the Fed starts cutting rates, thereby forming a relatively coordinated global rate cut cycle.

In this context, the performance of some G10 currencies such as the British Pound has been outstanding. Although the British Pound has mainly benefited from the risk improvement brought about by global loose monetary policies, the easing policies of the Bank of England should also provide some degree of support for the currency.

Goldman Sachs pointed out that the U.S. economy has a higher growth standard compared to other countries, which may alleviate the downward pressure on the U.S. dollar from the Fed's interest rate cuts