On September 19, 2024, the Federal Reserve embarked on a new round of interest rate cutsBy February 5, 2025, the U.S. dollar index saw a remarkable increase of nearly 8%, marking a phenomenon of a robust dollar during a rate cut cycleThe resilience of inflation and the risks of a rebound in the U.S. economy have compelled the Fed to maintain restrictive interest rates for a more extended periodConsequently, high interest rates in international financial markets may place pressure on China's foreign exchange market and risk asset valuations, thereby affecting the execution of China’s moderately loose monetary policy.

IThe Strong Dollar Will Persist Throughout This Rate Cut Cycle

Since the dissolution of the fixed exchange rate system in 1971, the strength and weakness of the dollar against foreign currencies have been represented by the dollar index, rather than gold pricesThe dollar index, with a base figure of 100 established in March 1973, initially included ten currenciesHowever, following the introduction of the euro on January 1, 1999, currencies like the German mark were replaced by the euro, which resulted in the dollar index comprising six currencies that continues to this dayNotably, the euro holds a weightage of 57.6%, becoming the most influential currency affecting the dollar indexThus, the dollar’s strength, as expressed by the dollar index, is contingent not only on the dollar itself but also on the strength of other currencies backing it, notably the euroHistorically, there have been multiple instances of a robust dollar during rate cut cycles, with notable examples occurring from 1974 to 1976, 1982 to 1985, 1992 to 1993, and 2008 to 2009.

In my view, the current round of interest rate cuts could lead to a prolonged period of a strong dollar due to two primary factors

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Firstly, the resilience and uncertainty surrounding U.S. inflation has forced the Fed to adopt a cautious approach, executing minor reductions in interest rates while maintaining them at restrictive levels for an extended time. Analyzing the U.S. economy, the unemployment rate is projected to decrease to 4.1% by December 2024. Data from the Bureau of Economic Analysis (BEA) indicates that the real GDP of the United States is expected to grow by 2.8% in 2024, primarily driven by consumer spending that contributes nearly 1.9 percentage pointsMoreover, the Personal Consumption Expenditures Price Index (PCE), reflecting inflation, is projected to rise by 2.5% year-on-year, with the core PCE rising by 2.8%, significantly exceeding the inflation target of 2%. The inflation trend suggests that, by the fourth quarter of 2024, the PCE and core PCE quarter-on-quarter annual rates could rise to 2.3% and 2.5%, respectively, compared to the third quarter’s rates of 1.5% and 2.2%.

By December 2024, the core PCE is anticipated to show a year-on-year increase of 2.8%, remaining stable for three consecutive months, underscoring its resilience and even the potential for a rebound riskCorporate profits also paint a relatively optimistic picture; in the third quarter of 2024, U.S. companies reported annualized profits of $3.8 trillion after adjustments for inventory valuation and capital consumption, remaining at historical highsThe U.SDepartment of Labor indicates that in 2024, hourly earnings in the private sector increased by 4.0%, with an increase of 3.9% recorded in DecemberThe earnings-wage-price cycle within the U.S. economy continues to exhibit robust trends, with the labor market becoming a pivotal factor supporting the resilience of inflation.

Secondly, other currencies, such as the euro, are entering their own rate cut cycles, with the overall economic fundamentals of the economies represented in the dollar index being weaker compared to that of the U.S. economy.

Examining the situation in the eurozone, inflation has shown signs of a rebound since September 2024. The European Central Bank (ECB) estimates that the eurozone’s inflation rate (HICP) will rise to 2.4% year-on-year by December 2024, and core HICP is expected to increase by 2.7%. The decline in base figures and the stickiness of service prices are significant contributors to the eurozone’s inflation surpassing the 2% target

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For the fourth quarter of 2024, eurozone GDP is predicted to grow by 0.9% (a minimal increase from just 0.1% growth in the previous year’s fourth quarter), although there are concerns regarding insufficient economic growth momentum, particularly as Germany’s economy is anticipated to decline by 0.2% in 2024, adversely impacting overall eurozone growthThe eurozone's unemployment rate for December 2024 is recorded at 6.3%, which is a slight increase of 0.1 percentage points compared to November.

As of early February 2025, the ECB has cut its policy interest rate to 2.9%, marking the fifth rate cut since June 2024, with a total reduction of 160 basis points, which is notably higher than the Federal Reserve’s three cuts totaling 100 basis pointsAmong the other economies influencing the dollar index, only the Bank of Japan is facing pressure to raise rates to curb inflationSince its cautious rate hike in March 2024, the Bank of Japan has increased rates to 0.5% three timesNonetheless, the Bank has indicated that Japan’s underlying inflation trend remains below 2%, opting to maintain accommodative policies to support price trends, albeit acknowledging limited room for further hikesAdditionally, examining the economic fundamentals of the UK, Canada, Switzerland, and Sweden reveals that except for Sweden, which exhibits a significantly lower inflation rate than 2%, the remaining economies have room for further cuts.

As for the implications of Fed policies for China, the new U.S. government is expected to bring considerable uncertainty regarding inflationOn January 29, 2025, the Federal Reserve's monetary policy statement indicated a pause in rate cuts, asserting that the labor market remains robust and inflation levels are still high, thus reflecting the necessity of extending the observation period to gauge inflation’s response to policies carefully to avoid the risks of inflation rebounding and triggering further rate hikes.

On December 18, 2024, the Fed released a summary predicting the median policy interest rate for 2025 to be 3.9%, still within restrictive territory

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Given that the economic fundamentals of most economies influencing the dollar index lag behind that of the U.S., it is likely that the rate cuts in these economies could exceed those conducted by the FedHence, the prevailing phenomenon of a strong dollar throughout this rate cut cycle is expected to continue for an extended period.

IIImpacts on China The Fed’s higher tolerance for inflation currently positions it between balancing inflation and employment (growth phases), and its impact on China’s economic and financial landscape manifests primarily across four dimensionsFirstly, there is a necessity to significantly lower expectations regarding the Fed’s future rate cuts.

The Federal Reserve has consistently prioritized employment; even with inflation hovering at elevated levels, it has still adjusted its rate cut expectationsThe Fed exhibits a high tolerance for an inflation rate in the range of 2% to 3%, a stance rooted in the new framework established in August 2020. This framework employs an average inflation targeting strategy, allowing inflation to exceed 2% for certain periods as long as the average inflation rate is maintained around 2% over time.

Given the new U.S. administration’s policies—such as reducing domestic taxes, imposing tariffs abroad, and implementing measures against illegal immigration—that could elevate U.S. inflation, market expectations are leaning towards further delays in rate cuts by the Fed.

Secondly, a “soft landing” for the U.S. economy is advantageous for Chinese exportsBased on recent estimates from the Fed, the U.S. economy is projected to grow at a rate of 2.1% in 2025, while the International Monetary Fund (IMF) forecasts it to reach 2.7% in its January 2025 reportPrivate consumption expenditures are driving nearly 1.87 percentage points of U.S

GDP growth in 2024, and notably, increases in the labor market wages have consistently outpaced inflation, supporting sustained real purchasing power enhancements.

According to data from the BEA, U.S. corporate profits remain at historically high levelsThe cycle of profit-wages-prices within the U.S. economy continues to demonstrate stability, with no evident factors disrupting this cycleConsequently, the increasing probability of a “soft landing” bolsters the economic fundamentals that support a strong dollarCustoms data indicates that, in dollar terms, China’s goods exports to the United States are expected to reach nearly $524.7 billion in 2024, constituting about 14.7% of total exports, with a trade surplus of approximately $361 billion, accounting for 36.4% of the overall trade surplus.

Furthermore, the new U.S. government's emphasis on “balanced trade” raises the risk of renewed economic frictions between the U.S. and China.

Advocating for “balanced trade,” the new administration is pushing for a substantial reduction in trade surpluses from key countries, especially with the U.S. economy’s “soft landing” potentially facilitating the U.S. in escalating trade frictions with ChinaRecent unilateral announcements from the U.S. introducing a 10% tariff on Chinese imports, coupled with demands for China to significantly increase imports of U.S. energy and agricultural products to balance bilateral trade, have ignited trade tensionsSimultaneously, the tangled tariff strategies directed at Mexico and Canada may also introduce risks to China’s re-export trade.

Lastly, the strong dollar might phase-wise influence the implementation of China’s moderately loose monetary policy.

In 2025, China planned to implement a moderately loose monetary policy to support the development of the real economy, with tools like reserve requirement ratio adjustments and interest rate reductions as key strategies

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