Is the old saying “Buy dollars, wear diamonds” truer now than before?
This saying suggests that by investing in dollars and bonds, one can accumulate enough wealth to afford luxury items like diamonds. However, in the current economic and political landscape, it is increasingly difficult to predict with reasonable certainty when the Federal Reserve will cut its key interest rates.
In the United States, the inflation rate for March was 3.5%, exceeding the expected 3.4% and higher than the 3.2% recorded in February 2024. This persistent inflation suggests that the previously anticipated interest rate cuts in 2024 may be too ambitious and should be reconsidered. Conversely, inflation in the Eurozone in March was 2.4% compared to 2.6% in February 2024, leading to expectations of a potential rate cut in June.
In this context, it can be argued that the saying “Buy dollars, wear diamonds” holds true also in the current period. This is because the Federal Reserve is expected to maintain higher interest rates for a longer period compared to the European Central Bank (ECB). Consequently, this implies higher returns for T-bills and strengthens the US dollar.
Given this framework, it is valuable to examine the relationship between the primary instruments that central banks use to implement monetary policy and their effects on exchange rates. The Federal Reserve’s commitment to keeping interest rates “higher for longer” is expected to result in a “stronger for longer” dollar, as higher interest rates attract foreign investments, thereby increasing demand for and the value of the US currency. This, in turn, impacts not only the currency market but also US stocks, as a strong dollar tends to depress US stock prices.
Recent market activity in other countries provides an example of how the interplay between currency and interest rates influences trader behavior and seeks higher returns. For instance, the recent surge in short positions on the sterling, reaching a 16-month high, reflects traders’ anticipation of interest rate cuts in the UK, potentially bringing them below US rates.
It is important to note that interest rate cuts not only aim to reduce borrowing costs but also have a significant impact on currency appreciation and depreciation. Therefore, understanding the complex relationship between central bank policies, inflation trends, exchange rates, and market sentiment is crucial for navigating these financial dynamics.
Author: Nicolò Pesaturo