The Fed may soon cut interest rates. That could make your next trip abroad more expensive (2024)

SeongJoon Cho/Bloomberg via Getty Images

The U.S. Federal Reserve may start cutting interest rates before year's end. That could make future trips abroad more expensive for the nation's travelers.

That's due to how interest-rate policy affects the strength of the U.S. dollar.

Here's the basic idea: An environment of rising U.S. interest rates relative to those in other nations is generally "dollar positive," said Jonathan Petersen, senior markets economist and foreign exchange specialist at Capital Economics.

In other words, rising rates underpin a stronger U.S. dollar versus foreign currencies. Americans can buy more stuff with their money overseas.

The opposite dynamic — falling interest rates — tends to be "dollar negative," Petersen said. A weaker dollar means Americans can buy less abroad.

Fed officials in June signaled they expect to cut rates once in 2024 and four additional times in 2025.

"Our expectation for now is the dollar will come under more pressure next year," Petersen said.

However, that's not necessarily a foregone conclusion. Some financial experts think the dollar's strength may have staying power.

"There have been quite a few headlines calling for the U.S. dollar's demise," Richard Madigan, chief investment officer at J.P. Morgan Private Bank, wrote in a recent note. "I continue to believe the dollar remains the one-eyed man in the land of the blind."

Why the U.S. dollar gives a 'discount' overseas

The Fed started raising interest rates aggressively in March 2022 to tame high pandemic-era inflation. By July 2023, the central bank had raised rates to their highest level in 23 years.

The dollar's strength surged against that backdrop.

The Nominal Broad U.S. Dollar Index is higher than at any pre-pandemic point dating to at least 2006, when the central bank started tracking such data. The index gauges the dollar's appreciation relative to currencies of the nation's main trading partners such as the euro, the Canadian dollar and the Japanese yen.

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For example, in July 2022, the U.S. dollar reached parity with the euro for the first time in 20 years, meaning they had a 1:1 exchange rate. (The euro has since rebounded a bit.)

In early July, the U.S. dollar hit its strongest level against the yen in 38 years.

A strong U.S. dollar gives "a discount on everything you're purchasing while you're abroad," Petersen said.

"In a sense, it's never been cheaper to go to Japan," he added.

A record number of Americans visited Japan in April, according to the Asian nation's tourism board. Benjamin Atwater, a communications specialist at InsideAsia Tours, a travel agency, attributes that partly to the financial incentive bestowed by a strong dollar.

In fact, he personally recently extended a work trip to Japan by a week and a half — instead of opting to travel elsewhere in Asia — largely because of the favorable exchange rate.

Everything from meals, hotels, souvenirs and the rental car were a "great value," said Atwater, who lives in Denver and has long wanted to travel to Japan.

"It was always portrayed as one of the most expensive places you can go, [but] I was getting some of best steaks I've ever had for like $12," he said.

How interest rates impact the U.S. dollar

In reality, the dynamics driving dollar fluctuations are more complex than whether the Fed raises or lowers interest rates.

The differential in U.S. rates versus other nations is what's significant, economists said. Fed policy doesn't exist in a vacuum: Other central banks are also simultaneously making interest-rate choices.

The European Central Bank cut interest rates in June, for example. Meanwhile, the Fed has kept rates higher for longer than many forecasters anticipated — meaning the rate differential between the U.S. and Europe has widened, helping support the dollar.

"The Fed's on hold, other central banks are getting ready to ease and the Bank of Japan (BoJ) seems stuck in a moment," J.P. Morgan's Madigan wrote.

U.S. Federal Reserve Chair Jerome Powell speaks during a Senate Banking, Housing, and Urban Affairs Committee hearing on July 9, 2024.

Bonnie Cash | Getty Images News | Getty Images

"If Japan wants the yen to stabilize, policy rates need to move higher," he added. "That doesn't appear to be happening anytime soon. With the ECB expected to cut ahead of the Fed, I expect current euro weakness to also prevail."

This is happening against the backdrop of a relatively strong U.S. economy, which also generally supports a strong dollar, Petersen said. At a high level, a strong economy means there will generally be higher economic growth and/or inflation, which means a greater likelihood the Fed will keep interest rates relatively high, he said.

A strong economy also typically incentivizes foreigners to park more money in the U.S., he said.

For example, investors generally get a better return on cash when interest rates are high. If an investor in Europe or Asia were getting perhaps 1% or 2% on bank account holdings while such holdings in the U.S. were yielding 5%, that investor might shift some money to the U.S., Petersen said.

Or, an investor might want more to hold more of their portfolio in U.S. rather than European stocks if the economic growth outlook wasn't good in Europe, he said.

In such cases, foreigners buy dollar-denominated financial assets. They'd sell their local currency and buy the dollar, a process that ultimately bids up the dollar's strength, Petersen said.

Exchange rates "all come down to capital flows," he said.

While these dynamics also hold true in emerging markets, currency fluctuations can be more volatile than in developed nations due to factors like political shocks and risks to commodity prices like those of oil, he added.

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The Fed may soon cut interest rates. That could make your next trip abroad more expensive (2024)

FAQs

The Fed may soon cut interest rates. That could make your next trip abroad more expensive? ›

A weaker dollar means Americans can buy less abroad. Fed officials in June signaled they expect to cut rates once in 2024 and four additional times in 2025. “Our expectation for now is the dollar will come under more pressure next year,” Petersen said. However, that's not necessarily a foregone conclusion.

What does the Fed cutting interest rates mean? ›

If the Fed decides to cut its key interest rate — which is currently at a 23-year high — consumers could see lower borrowing costs for home loans and credit cards, but the extent of the impact will depend on the size of the cut.

What will happen if Fed hikes rates? ›

What Happens When The Fed Raises Rates? The main reason why the Federal Reserve increases interest rates is to increase the cost of credit throughout the economy. As financial institutions themselves have to pay a price for borrowing money, an interest rate hike means it will cost them more to borrow the same amount.

What does the Fed do to interest rates if the economy is not doing well? ›

And the stronger demand for goods and services may push wages and other costs higher, influencing inflation. During economic downturns, the Fed may lower the federal funds rate to near zero. In such times, the Fed can use other tools to influence financial conditions in support of its goals.

What happens to the economy when interest rates are high? ›

A higher interest rate environment can present challenges for the economy, which may slow business activity. This could potentially result in lower revenues and earnings for a corporation, which could be reflected in a lower stock price.

What are the benefits of cutting interest rates? ›

Lower rates make borrowing money cheaper. This encourages consumer and business spending and investment and can boost stock prices. Lower rates can also lead to inflation, which undermines the effectiveness of low rates. Higher rates discourage spending and can depress company returns and, therefore, stock prices.

What is the disadvantage of cutting interest rates? ›

Even without such mishaps, future repayments are likely to reduce consumption and investment. Another side effect is that low and negative rates can lift asset prices. Lower interest rates push investors into riskier assets and argue for higher prices on property and shares, asset gains that tend to boost inequality.

Who benefits from high interest rates? ›

With profit margins that actually expand as rates climb, entities like banks, insurance companies, brokerage firms, and money managers generally benefit from higher interest rates. Central bank monetary policies and the Fed's reserver ratio requirements also impact banking sector performance.

How does the US interest rate affect the world? ›

1 Historically, rising interest rates have gone hand-in-hand with an appreciating U.S. dollar. This, in turn, affects economic facets domestically and around the world—particularly the credit market, commodities, stocks, and investment opportunities.

Who benefits when the Fed raises rates? ›

On the positive side, higher interest rates can benefit savers as banks increase yields to attract more deposits. The average savings yield is now almost 10 times higher than it was when the Fed first started raising rates, and online banks often offer even higher yields.

Where to put your cash after the Fed's interest rate increase? ›

Since savers don't know which way rates will move next, advisers often recommend a CD ladder. This means buying a series of CDs with progressively later maturity dates. Laddering ensures that some portion of your savings matures each year and can be spent or moved into other investments as rates change.

Do banks make more money when interest rates rise? ›

Higher interest rates have boosted banks' net interest income—resulting in higher net interest margins (NIMs) and enhanced profitability. Lenders have benefited from a widening of the spread between the interest they pay to depositors, and the income they reap on lending.

Who benefits when yields or interest rates are low? ›

When yields or interest rates are low, it typically benefits borrowers more than lender...

What will happen if the Fed cuts rates? ›

Larger rate cuts would provide welcome relief to borrowers, including home and car buyers who have been priced out of the market due to high financing costs. The downside would be felt by savers, given that high-interest rate savings accounts and CDs would likely offer less favorable terms following Fed cuts.

Who gets the money from higher interest rates? ›

Interest rates and bank profitability are connected, with banks benefiting from higher interest rates. When interest rates are higher, banks make more money by taking advantage of the greater spread between the interest they pay to their customers and the profits they earn by investing.

Would lowering interest rates help the economy? ›

A rate reduction this fall — the first since the pandemic — would amount to a momentous shift and a potential boost to the economy. Fed rate cuts, over time, typically lower borrowing costs for such things as mortgages, auto loans and credit cards.

Do mortgage rates go down when the Fed cuts rates? ›

Future rate cuts may provide a sugar high to the U.S. economy and could lead to lower mortgage rates, though they have already started to come down in anticipation of future rate cuts.

Does cutting interest rates increase money supply? ›

What Is the Connection Between the Money Supply and Interest Rates? A nation's money supply and interest rates have an inverse relationship. Interest rates should be lower if there's a higher supply of money in a country's economy. Rates should be higher if the money supply is lower.

What happens to stocks when the Fed cuts rates? ›

Stocks have typically risen in the six- to 12-month period following the Fed's first rate cut, as long as the economy avoids recession, Truist's research showed. Lower interest rates could also help broaden the equity rally, which has been led by a handful of megacap companies like Nvidia (NVDA.

Does cutting interest rates cause inflation? ›

Decreasing the policy interest rate can stimulate economic activity and cause inflation to rise. Lower interest rates encourage people to spend more and save less.

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