- On 12 June the Federal Reserve held rates and, in its projections, left a single cut expected for the rest of the year.
- The United States and Europe were moving at different speeds, and that difference tends to show up in currencies.
- Anyone with assets or debts in dollars should know what part of their wealth is exposed to that currency.
On 12 June 2024, the US Federal Reserve held interest rates and, in its new projections, reduced the expected cuts for the rest of the year to just one. A few days earlier, the ECB had done exactly the opposite: cutting rates for the first time in almost five years. The difference between the two decisions, within a matter of days, is precisely what deserves attention.
The two most influential central banks in the western world were thus heading in different directions. That is not a contradiction but the reflection of economies evolving differently. It does, however, have practical consequences for anyone operating on both sides of the Atlantic, because interest rates are one of the factors that most influence the value of one currency against another.
What the Fed said
From time to time, the central bank’s members publish their projections for rates, inflation and growth. They are a guide to the institution’s thinking, not a fixed timetable. On this occasion, the message was that the path of cuts could be slower than some had expected.
A central bank publishes these projections to guide the market, although they are not a promise. If the data change, the projections change too, and it would not be the first time that the actual path of rates departs from what was announced a few months earlier. That is why they are read with interest, but with caution. What matters to a company or a family is not guessing the date of the next decision but understanding the range of reasonable scenarios.
Two different speeds
The United States and Europe were moving at different speeds. When two major central banks do not move together, the rate gap between the two economies tends to show up in currencies. If rates are higher on one side, investing there becomes more attractive, and that increases demand for its currency. It is the same mechanism, on a global scale, by which a saver compares what each bank pays.
The result is that the euro and the dollar can move more than ordinary economic news would suggest. For a company that sells in dollars or buys commodities priced in that currency, a move in the exchange rate can change the margin on a deal even though the dollar price has not changed. It is a silent risk, noticed only once it has materialised. Companies that invoice in one currency and pay their costs in another know it well, and individuals notice it when travelling or buying abroad.
The exchange rate
For anyone with assets or debts in dollars, the interest-rate gap affects the exchange rate and therefore the value of what they hold. An investor with a dollar-denominated portfolio, a family with expenses in that currency or a company that invoices US clients are, to a greater or lesser extent, exposed to its moves. That exposure may be small or significant, and knowing its size is what allows one to decide whether it matters.
It is worth knowing what part of one’s wealth or commitments is exposed to the dollar and whether that exposure is deliberate. If it is, that is fine; if not, it can be reduced with simple measures or with hedging instruments. In both cases, having the numbers clear is the first step, and the adviser can help measure that risk before it is felt. A yearly review, or one whenever the structure of income and spending changes significantly, is usually enough.
Currencies are a risk that can be measured before it is felt.
This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.
