In this round of Fed rate cuts, which currency performs the best?

Analyzing the interest rate cuts by the Federal Reserve in the past, studying the trend of the US dollar, Goldman Sachs believes that monetary policy coordination is key. Is the magnitude of interest rate cuts by the Federal Reserve important relative to other central banks? Which currency will stand out in this round of interest rate cuts?

In its latest report on Thursday, Goldman Sachs pointed out that the magnitude and speed of interest rate cuts by the Federal Reserve did not have a clear impact on the performance of the US dollar. Even during a Federal Reserve interest rate cut cycle, the US dollar may not necessarily underperform other currencies. On the contrary, the coordination of interest rate cuts and the macroeconomic environment are more important.

In this round of interest rate cuts, the Federal Reserve's upcoming cuts can already be classified as "policy coordination," and the US economy is relatively strong.

The Goldman Sachs report also stated that in the current interest rate cut cycle, the British pound may perform the best. Although market volatility is expected to increase, the British pound tends to perform well in environments of low volatility, declining yields, and rising stock markets, and the Bank of England has a cautious stance on interest rate cuts, which may support the strength of the British pound.

Is the magnitude of interest rate cuts by the Federal Reserve important relative to other G10 central banks?

Goldman Sachs points out that foreign exchange is a relative "game," where the coordination of interest rate cuts and the macroeconomic environment are more important.

Goldman Sachs defines the magnitude of an interest rate cut cycle as the peak to trough of policy rates, and speed as the number of loose months from peak to trough, including months with discontinuous rate cuts.

Goldman Sachs found that the magnitude or speed of interest rate cuts by the Federal Reserve relative to other G10 countries did not have a clear or consistent impact on the performance of the US dollar. Although historically, large interest rate cut cycles by the Federal Reserve (such as in 2001, 2008, and 2020) are usually associated with a strong US dollar, this is mainly due to policy coordination and the macroeconomic environment.

For each interest rate cut cycle from 1995 to 2020, Goldman Sachs classifies a cycle as "coordinated" if at least four other G10 central banks started cutting rates within 6 months of the Federal Reserve's cuts; otherwise, it is considered uncoordinated. In coordinated rate cut cycles, the US dollar tends to perform stronger, especially during economic recessions, as seen in 2001, 2008, and 2020, where the US dollar was relatively stronger compared to other safe-haven currencies.

However, there are exceptions. The interest rate cut cycle in 1998 was an exception, as despite being a coordinated cycle, the US dollar did not show the expected strength during this period. This was due to global financial market turmoil at the time, with financial crises in Asia and Russia affecting global markets and worsening US financial conditions.

Regarding the assessment of this interest rate cut cycle, Goldman Sachs stated:

When comparing the current interest rate cycle with historical cycles, there is no previous cycle that can fully analogize the current situation. Although the cycle in 2007 is considered a potential comparison, the current Federal Reserve interest rate cut cycle already has coordination and the US economy is relatively strong, with any risks of an economic recession potentially affecting other countries.

Will the British pound be the best-performing currency in this accommodative cycle?

The Goldman Sachs report suggests that in the current interest rate cut cycle, the British pound may stand out: Although the expected market volatility is increasing, the British pound tends to perform well in environments of low volatility, declining yields, and rising stock markets. Additionally, the UK economy is relatively more resilient compared to other regions in Europe, and the Bank of England has a lower inclination to cut interest rates, which supports the strength of the pound.

Furthermore, British stocks have been more favored during recent turbulent periods, which is one of the reasons why Goldman Sachs is bullish and believes in additional fund inflows