Federal Reserve rate cut triggers chain reaction | Global capital flows and investment strategies in the era of US dollar decline

In 2024, the Federal Reserve officially begins a rate-cutting cycle, and this is not just an American issue. When U.S. interest rates are lowered, the map of global capital flows will be redrawn. This article provides an in-depth analysis of the logic behind the dollar’s decline, the response strategies of various asset classes, and how investors should seize this wave of change.

Why Is the Dollar Starting to Weaken as the Rate-Cut Cycle Begins?

A Simple Understanding of the Essence of Rate Cuts

Cutting interest rates means money becomes cheaper. When U.S. interest rates decline, the returns on holding dollars decrease accordingly, prompting capital to seek higher yields elsewhere. According to the latest Fed dot plot, the goal is to bring the benchmark interest rate down to around 3% by 2026.

This may sound like a moderate adjustment, but in reality, it triggers a series of market reactions—not just for the dollar itself, but for the entire global financial market re-pricing.

The Direct Cause of the Dollar’s Decline

The relationship between interest rates and exchange rates is the most direct. High interest rates attract capital inflows, while low rates do the opposite. When the U.S. cuts rates, the dollar’s attractiveness gradually diminishes, and investors start shifting toward higher-yield assets like cryptocurrencies, gold, stocks, and others. That’s why, during a rate-cut cycle, the dollar often declines alongside gold rising and Bitcoin strengthening.

The Logic Behind the Operation of the U.S. Dollar Exchange Rate

What Is an Exchange Rate?

An exchange rate is the ratio at which one currency can be exchanged for another. For example, EUR/USD indicates how many U.S. dollars one euro can buy. When EUR/USD rises from 1.04 to 1.09, it means the euro is appreciating and the dollar is depreciating; the opposite is also true.

The Relationship Between the U.S. Dollar Index and Other Currencies

The U.S. Dollar Index (DXY) does not exist in isolation; it is a weighted index of the dollar against a basket of major currencies (euro, yen, pound, etc.). Many believe that U.S. rate cuts automatically lead to a decline in the dollar index, but this logic is incomplete.

The truth is: U.S. rate cuts do not necessarily cause the dollar index to fall; it also depends on the monetary policy actions of other countries. If the European Central Bank cuts rates more aggressively and more frequently than the Fed, the euro may depreciate relative to the dollar, potentially causing the dollar to appreciate. The core of exchange rate competition is “relative strength,” not absolute strength.

Four Core Factors Influencing the Dollar’s Trend

1. Interest Rate Policies: The Most Attention-Grabbing Signal

Interest rates are the most direct driver of the dollar, but the key lies in expectation management. The market does not wait for rate cuts to officially begin before reacting; it discounts future policy changes in advance.

A common mistake investors make is only looking at current interest rates and ignoring future expectations. The Fed’s dot plot, officials’ speeches, and economic data are all signals issued ahead of time. Smart capital has already started moving when these signals appear; by the time official announcements are made, most of the exchange rate adjustments are already completed.

2. U.S. Money Supply: The Impact of QE and QT

Quantitative easing (QE) involves the Fed printing money and increasing market liquidity; quantitative tightening (QT) is the opposite, reducing liquidity.

QE pushes up asset prices but dilutes the dollar’s value; QT does the reverse. Currently, the Fed is in a phase of simultaneous rate cuts and QT—cutting rates while shrinking the money supply. This creates a delicate environment: a reduction in dollar supply could support the dollar, but the low-interest-rate environment tends to push it down. The tug-of-war between these forces determines the speed and extent of the dollar’s decline.

3. International Trade Structure and Trade Deficit

The U.S. has long-standing trade deficits (imports > exports). When imports increase, companies need more dollars to pay for goods, which can temporarily support the dollar; but in the long run, trade deficits reflect a decline in U.S. competitiveness, raising concerns about confidence in the dollar.

It’s worth noting that future trade policies could become more aggressive. If tariffs and trade conflicts with major trading partners intensify, making business more difficult, this will further erode demand for the dollar.

4. Global Confidence and the De-dollarization Trend

This is the most easily overlooked but has the most long-term impact. The dollar’s status as the global reserve currency is built on trust—trust in the U.S. economy, political stability, and creditworthiness.

In recent years, this trust has been gradually eroding. The wave of de-dollarization is becoming more apparent:

• The EU has established an independent payment system
• The renminbi is increasingly used for international trade settlement
• Many central banks are reducing holdings of U.S. Treasuries and turning to gold
• The rise of blockchain technology offers alternatives outside the dollar

If the de-dollarization trend continues, the dollar’s liquidity will gradually decline, creating long-term structural pressure for the dollar to weaken.

The Half-Century Trajectory of the Dollar: From Bretton Woods to Today

Looking back over the past 50 years of the dollar index, several key moments have profoundly influenced exchange rates:

2008 Financial Crisis — During global panic, capital flocked into the dollar seeking safety, causing a sharp appreciation.

2020 Pandemic Shock — The Fed launched massive QE to stabilize markets, temporarily weakening the dollar; but as the U.S. economy led the recovery, the dollar rebounded strongly.

2022-2023 Aggressive Rate Hikes — The Fed fought inflation with rate hikes, pushing the dollar to extreme strength, with the dollar index briefly surpassing 114.

2024-2025 Rate Cuts Begin — Inflation is under control, and the Fed starts lowering rates, reducing the dollar’s safe-haven appeal, prompting capital to flow into cryptocurrencies, gold, and emerging markets.

History shows that the dollar’s movement is determined by multiple intertwined factors; no single factor can fully explain its trajectory.

What About the Dollar’s Decline? Exchange Rate Predictions for the Next Year

Based on the current situation, the following factors are worth close attention:

Factors Likely to Weaken the Dollar (Dominant):

• Continued rate-cut cycle, narrowing interest rate differentials
• No reversal in the de-dollarization trend
• Potential escalation of trade conflicts, damaging U.S. competitiveness
• Reallocation of global capital from the dollar to other assets

Factors That Might Support the Dollar:

• Sudden geopolitical risks, making the dollar the ultimate safe haven
• Unexpected strength in the U.S. economy, delaying rate cuts
• Other major currencies facing their own issues (e.g., weak European economy, Japanese inflation struggles)

Core Judgment: Over the next 12 months, the most likely trend for the dollar index is oscillation at high levels followed by gradual weakening, rather than a one-way sharp decline. The reason is simple—this depends on the relative actions of central banks. If the U.S. cuts rates but Europe and Japan cut more and faster, the dollar will strengthen; otherwise, it will weaken.

Importantly, rate cuts do not directly equate to a falling dollar. The market evaluates overall changes in relative yields, growth expectations, and risk appetite, not just a single factor.

How Do Different Assets Perform in a Dollar-Down Environment?

Gold: The Biggest Winner

When the dollar declines, gold usually performs best. The reasons are twofold:

1. Gold is priced in dollars; a weaker dollar reduces gold’s cost in other currencies, increasing demand.
2. A rate-cut environment lowers the opportunity cost of holding gold (which has no interest), making it more attractive.

Simply put, when the dollar weakens and interest rates fall, gold’s appeal as a traditional safe-haven asset rises significantly.

Cryptocurrencies: New Capital Inflows

In an environment of declining dollar purchasing power, the crypto market often attracts capital. Investors seek assets to hedge inflation, and Bitcoin is often called “digital gold.”

Especially during global economic turbulence and waning confidence in traditional currencies, blockchain assets become new destinations for capital. This aligns with the broader de-dollarization trend—an increasing diversification of store-of-value assets.

Stock Markets: Opportunities and Risks

Rate cuts typically drive capital into equities, especially technology and growth stocks (as low rates support high valuations).

However, if the dollar weakens too much, foreign investors might shift toward Europe, Japan, or emerging markets, reducing the attractiveness of U.S. stocks. It’s a delicate balance—the liquidity benefits of rate cuts can be offset by exchange rate risks from dollar depreciation.

Specific Outlook for Major Currency Pairs

USD/JPY (U.S. dollar / Japanese yen)

As Japan ends its ultra-low interest rate era, capital begins to flow back into Japan. The yen is expected to appreciate, and USD/JPY may face depreciation pressure. This is a relatively clear direction within the dollar’s downtrend.

USD/TWD (U.S. dollar / Taiwan dollar)

Taiwan’s interest rate policy often follows the U.S., but domestic challenges (like housing prices) make rate cuts difficult. Plus, Taiwan’s export-oriented economy benefits from a weaker currency. Expect the TWD to appreciate modestly.

EUR/USD (Euro / U.S. dollar)

Currently, the euro is relatively strong, but Europe faces its own challenges—persistent inflation and sluggish growth. If the European Central Bank also cuts rates, the dollar’s relative strength will improve, preventing a sharp depreciation.

How to Invest in a Dollar-Down Environment?

First Step: Recognize Volatility as Opportunity

A declining dollar is not a linear process but a volatile downward trend. Every short-term rebound, economic data release, or central bank statement can trigger small fluctuations. CPI reports, employment data, Fed meetings—these are moments of significant exchange rate volatility.

Short-term traders can operate around these events but need to be sensitive to information and execute quickly.

Second Step: Structural Changes Require Long-Term Strategies

De-dollarization, global financial restructuring, diversified asset allocation—these are processes that unfold over 5-10 years.

Long-term investors should consider:

• Gradually increasing gold holdings
• Focusing on emerging markets and non-dollar assets
• Positioning in technology and growth stocks that benefit from low-rate environments
• Evaluating the role of cryptocurrencies in their portfolios

Third Step: Uncertainty Creates Opportunities

Geopolitical risks, economic shocks, policy shifts—any black swan event can disrupt expectations. When expectations are shattered, capital flows and prices are re-priced.

Smart investors do not try to predict the future perfectly but prepare for multiple scenarios. In a declining dollar environment, maintaining awareness of global liquidity flows and identifying where capital is exiting and entering is key to winning.

Conclusion

The Fed’s rate-cut cycle marks the beginning of a new era. The dollar’s decline is not just about exchange rates; it reflects a reshaping of global capital flows, reserve currency patterns, and the evolution of a multipolar financial system.

Rather than passively waiting for market volatility, it’s better to understand these structural changes in advance and proactively adjust asset allocations. Opportunities always favor those who are prepared.