Investors who are betting that any interest rate cuts will prompt the US dollar to fall might end up being disappointed, according to T. Rowe Price’s Quentin Fitzsimmons. 
The dollar has performed strongly against other currencies over the past decade, reflecting the fact that the US is the world’s largest economy and one of the major destinations for investors’ cash.
However, with the US central bank recently cutting rates, some have expressed concern about the future direction of the dollar.
Performance of dollar against sterling, euro and yen over 10yrs
Source: FE Analytics
But Fitzsimmons, a portfolio manager on the T. Rowe Price Global Aggregate Bond fund, believes that this is not as big a risk to the dollar as some fear and sees other reasons to be positive.
Below, the manager highlights five US dollar dynamics that investors need to monitor over the short run.
Rate cuts do not always trigger dollar weakness
After a period when the US Federal Reserve was seeking to ‘normalise’ its monetary policy through gradually increasing interest rates, the central bank cut them in September citing concerns about slowing global growth and the trade war. This was only the second interest rate cut since the crisis of 2008.
Although interest rate cuts tend to be associated with currency depreciation, Fitzsimmons pointed that the dollar does not always follow this pattern – indeed, the greenback has only weakened once during the last four US rate-cutting cycles.
“With this in mind, going underweight the dollar because the Federal Reserve is expected to cut could be a dangerous game,” he said. “There are many other factors needed to be taken into consideration.”
Growth differentials drives dollar more than growth
Much has been made of the fact that the US economy has been slowing in recent months but Fitzsimmons argued that this should not be overly concerning for the dollar – which has remained strong this year despite the slowdown.
“This is because the way the US economy performs relative to other countries influences the currency more than US growth per se,” he explained. “So far in 2019, European growth has disappointed more than US growth.”
Italian economic growth, the manager noted, stagnated in 2019’s second quarter while the UK was hit by a contraction in the three months to June. In addition, Germany – Europe’s largest economy – has seen its manufacturing sector fall into 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,” said the T. Rowe Price manager.
Dollar remains attractive from a carry perspective
The US dollar offers investors one of the highest carry rates (carry is the return associated with holding an asset) in the developed market space, according to Fitzsimmons.
“Despite recent rate cuts, the dollar is likely to remain attractive for some time from a carry perspective – this is because US rates are so much higher than places such as Japan and Switzerland, where rates are negative,” he said.
However, the manager argued that US dollar-based assets can be “less appealing” for foreign investor when hedging costs are considered.
He gave the example of US 10-year Treasuries, which appear much more attractive than 10-year German bunds at first look. But the yield advantage “effectively disappears” if the cost of hedging dollars back to euros is taken into consideration.
Performance of dollar vs renminbi over 2yrs
Source: FE Analytics
Tariffs create currency volatility, not direction
Fitzsimmons said that the impact of the next dynamic – trade 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,” Fitzsimmons explained.
In fact, he noted that this might have been “an unintended consequence” of the trade tariff strategy which US president Donald Trump has been using against China.
As an example, the manager pointed put that Chinese authorities let the renminbi drop to its lowest level versus the dollar in more than a decade after a recent and challenging round of tariff negotiations, while keeping its value relatively unchanged versus a broad basket of other currencies.
“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,” he continued. “Against this backdrop, volatility is expected. Perhaps the best way to benefit from this is through the use of currency options.”
Safe haven status of the dollar remains intact
The final factor that could continue to support the dollar is the fact that investors tend to flock to the greenback in times of market stress and Fitzsimmons does not see any reason for this trend to change in the foreseeable future.
“The US dollar is where liquidity ends up being trapped in this low-yield environment,” the T. Rowe Price manager said. “This trend is amplified by the inversion of the US Treasury curve, as parking cash in money market funds has become much more attractive now.”
Of course, the Swiss franc and the Japanese yen are other well-known ‘safe haven’ currencies that have performed well in 2019’s uncertain environment. But the manager concluded: “The dollar remains king for investors looking for safety. This is unlikely to change.”
Performance of fund vs sector since launch
Source: FE Analytics
The $466.4m Luxembourg-domiciled T. Rowe Price Global Aggregate Bond fund, which Fitzsimmons manages with Arif Husain, launched in October 2015 and invests in a range of bonds from all over the world aiming to maximise the value of and income from its holdings.
Since launch, it has made a 135.71 per cent return – compared with a 120.41 per cent return from its average IA Global Bonds peer. It has ongoing charges of 0.62 per cent.