Interest rates are a powerful tool in the world of economics and finance, with the ability to influence everything from mortgage payments to global trade.
It also has a significant impact on currency values. In this article, we’re focusing on the relationship between interest rates and the US dollar.
Typically, when interest rates in the United States rise, so does the value of the dollar. But this isn’t always the case.
Understanding the relationship between interest rates and the dollar can help businesses manage currency risk and protect their bottom lines.
In this article, we’ll explore how interest rates affect the value of the dollar, look into some real-world examples, and consider how recent political events, like Donald Trump’s 2024 election victory, might impact the dollar in the near future.
Table of contents
- What are interest rates and how do they work?
- The relationship between interest rates and the dollar
- How post-pandemic rate hikes boosted the dollar
- How a strong dollar impacts the global economy
- How a weak dollar can boost growth
- How will Trump affect interest rates and the dollar?
- Why does this matter for businesses?
- Conclusion: understanding interest rates and the dollar’s impact on business
- 10 FAQs about how interest rates affect the dollar
What are interest rates and how do they work?
Interest rates represent how much money you’ll earn for your savings or how much it’ll cost you to borrow money. They affect everyone, from individuals to businesses.
In the US, the Federal Reserve (the Fed) — the nation’s central bank — sets the federal funds rate, which affects interest rates across the country. This rate impacts loans, mortgages, and savings accounts offered by banks.
The Fed uses interest rates to keep inflation under control and to boost economic growth.
When inflation becomes too high, the Fed will raise interest rates to make borrowing money more expensive and saving more valuable. In doing so, spending in the US decreases, lowering prices and, therefore, inflation.
On the other hand, when economic growth needs a lift, the Fed will look to cut interest rates, making loans cheaper, and encouraging more spending.
While the two factors above are the main motivators behind why the Fed will raise rates, changes to them also impact the dollar. Let’s break down their relationship.
Read: How does inflation affect exchange rates?
The relationship between interest rates and the dollar
Interest rates and the dollar share a close, often inverse, relationship. When US interest rates rise, the dollar tends to strengthen. Here’s why:
Higher interest rates attract foreign investment
When the US raises interest rates, overseas investors become more drawn to assets valued in dollars.
Higher rates mean a higher return on investment, which can lead foreign investors to buy US assets, such as Treasury bonds.
To purchase these assets, they first need to buy dollars, increasing demand for the currency and driving up its value.
Lower interest rates make the dollar less attractive
On the other hand, when US interest rates fall, the dollar becomes less attractive to investors.
They may seek better returns in other currencies, such as the yen, euro or pound sterling — reducing demand and weakening the dollar.
Inflation and currency devaluation
If interest rates remain low for too long, inflation can rise, decreasing the dollar’s purchasing power. This can also weaken the dollar, as investors seek currencies that promise higher returns or more stability.
How post-pandemic rate hikes boosted the dollar
Between 2021 and 2023, the Covid-19 pandemic and war between Russia and Ukraine pushed global inflation to multi-decade highs.
To tackle US inflation that reached a 40-year peak in June 2022, the Fed launched a series of aggressive rate hikes, raising interest rates from near zero to over 5% in under two years.
As a result, the dollar surged to its highest level in 20 years against many other currencies as investors jumped on the soaring rates.
The US dollar index (DXY), which measures the dollar’s value against a basket of major currencies, rose significantly. This made imports cheaper for American businesses but exports more expensive for foreign buyers.
How a strong dollar impacts the global economy
A strong dollar can have wide-ranging effects across the global economy:
Lower export competitiveness
When the dollar strengthens, US goods and services become more expensive for foreign buyers, which can lead to a decline in exports. American companies that rely heavily on exports may see their revenues decrease.
Higher import costs for other countries
For countries that import a lot of goods priced in dollars, such as oil, a strong dollar means higher import costs. This can contribute to inflation in those countries, forcing their central banks to adjust their own monetary policies.
Impact on emerging markets
Many emerging market economies borrow money in dollars. This is because the dollar is widely accepted as the world’s reserve currency, making it popular for international loans and trade agreements.
Also, loans in US dollars tend to have lower rates than some local currencies, making borrowing more attractive initially.
When the dollar strengthens, it becomes more expensive for these countries to pay their debts, potentially leading to economic instability.
We’ve seen the impact of this in Turkey’s currency crisis when, in 2018, the dollar strengthened, and the Turkish lira depreciated significantly.
With much of its corporate debt denominated in dollars, Turkish businesses struggled to meet repayment obligations, leading to widespread economic turmoil.
In November 2017, the exchange rate between US dollars and Turkish lira was 3.91. In the seven years following, the rate rose by over 750%, reaching 34.42 in November 2024.
How a weak dollar can boost growth
While a strong dollar has its advantages, a weaker dollar can also benefit the US economy:
Increased export competitiveness
A weaker dollar makes US goods and services more affordable for foreign buyers, which can increase demand for American products abroad.
This can lift revenues for US businesses, particularly those with customers overseas.
Tourism and investment
A weaker dollar makes it cheaper for some foreign tourists to visit the US and for foreign businesses to invest in US assets. This can bring additional revenue into the country.
Commodity prices
Commodities like oil, gold, and coffee are priced in dollars. When the dollar weakens, demand for commodities rises, pushing prices up. This can benefit US industries involved in commodity exports.
Read: Why is coffee in the UK so expensive?
How will Trump affect interest rates and the dollar?
With Donald Trump set to take top spot in the White House in January 2025, there’s widespread speculation about how his administration’s policies could affect interest rates and the dollar.
Initial reactions to Trump’s 2024 victory
In the days following Trump’s election victory on 5th November, markets saw a significant response.
Stocks soared, Bitcoin broke record levels, and the dollar rallied sharply.
This immediate reaction reflects investor optimism about Trump’s pro-business stance and his plans for tax cuts and deregulation.
However, the long-term impact on the dollar is more nuanced and may depend on several factors.
Potential for higher inflation and interest rates
Under Trump’s first term, we saw a mix of tax cuts and increased spending. This encouraged economic growth but also increased deficits.
If Trump pursues similar policies in his next term, we could see higher inflation in the US. If inflation was to rise, it’d likely prompt the Fed to raise interest rates, which could initially strengthen the dollar.
However, if inflation remains high, it could eventually harm the dollar’s value. This is because sustained high inflation typically reduces the purchasing power of the dollar, making goods and services more expensive domestically.
As inflation reduces the real value of returns on dollar-denominated investments, foreign and domestic investors may look to other currencies or assets. This could decrease demand for the dollar and put downward pressure on its value.
Mixed effects on the dollar’s strength
While higher interest rates may attract foreign investment in the short term, Trump’s America-first policies could lead to trade tensions or fiscal concerns that make foreign investors cautious about holding dollars.
A rising deficit or renewed trade disputes could weigh on the dollar’s long-term strength, especially if investors perceive greater risks in holding US assets.
However, despite Trump sharing his desire to weaken the dollar earlier in 2024, his policies may lead to the opposite effect.
Trump and his now vice president, JD Vance, have spoken about intentionally devaluing the dollar to boost US manufacturing and lower the trade deficit.
However, the globalised world is currently bracing itself for heavy trade tariffs from the Trump administration. If they come into effect, they’ll likely put pressure on smaller economies, stunting their growth, weakening their currencies, and boosting the dollar.
According to James Lord, global head of FX at Morgan Stanley, Trump’s tariffs will likely lift the world’s reserve currency. He stated:
“Tariffs, all else being equal, will result in a stronger dollar, particularly if retaliation from trading partners in the form of tariffs raises additional growth risks for the global economy.”
Overall, Trump’s impact on the dollar and interest rates remains uncertain and will likely depend on a balance between pro-growth policies and potential inflationary pressures.
Read: How Trump’s tariffs could impact businesses in 2025
Why does this matter for businesses?
Understanding the relationship between interest rates and the dollar is essential for businesses engaging in international trade or managing cross-border payments. Here’s why:
Cost management
Constant changes to the dollar’s value directly impacts the cost of imported goods and services. A stronger dollar can reduce costs for US businesses importing materials priced in foreign currencies, while a weaker dollar can make imports more expensive.
For businesses outside the US, the opposite is true. UK or European businesses, for instance, may exploit cheaper US imports when interest rate cuts lead to a lower dollar. However, Fed rate hikes pushing the dollar higher mean it’ll cost more to pay for US goods or services.
Revenue forecasting
For US exporters, a weaker dollar can boost revenues. A low dollar makes US goods and services more competitive as they become more affordable for foreign buyers. Conversely, a stronger dollar may reduce demand for exports, potentially limiting revenue growth.
Hedging currency risks
Volatile interest rates can lead to unpredictable currency movements, creating risks for businesses with international operations.
To limit these risks, your business can consider implementing foreign exchange (FX) hedging strategies.
Privalgo uses FX products like forward contracts as part of currency hedging strategies to secure favourable rates of exchange, helping businesses like yours budget more effectively and protect your bottom line.
Debt management
For businesses with loans denominated in US dollars, a strengthening dollar can make repayments more costly, particularly for those operating in emerging markets.
Monitoring interest rate trends enables companies to better manage and forecast their debt obligations.
Global competitiveness
The dollar’s strength influences pricing, supply chains, and profit margins. Businesses that understand these dynamics can position themselves more strategically in international markets, ensuring they remain competitive despite currency fluctuations.
Conclusion: understanding interest rates and the dollar’s impact on business
Understanding how interest rates affect the US dollar is not just an exercise in economic theory — it’s a necessity for businesses engaged in the global economy.
As interest rate changes ripple through currency markets, they directly influence costs, revenues, and the bottom lines of businesses around the world.
For companies engaging in international trade or managing cross-border payments, staying ahead of these fluctuations is crucial.
From reducing the risks of currency volatility through hedging strategies to leveraging market opportunities when the dollar strengthens or weakens, proactive planning and informed decision-making can transform challenges into growth opportunities.
By monitoring interest rate trends and their impact on the dollar, businesses can gain a competitive edge and safeguard their operations against financial uncertainty.
Alternatively, businesses can work with an international payments specialist to do all the monitoring for them.
At Privalgo, our team of currency specialists remain up to date with interest rates changes and other major economic events to ensure you’re made aware of the potential impacts they could have on your international payments.
They can help you build tailored FX risk management strategies to bring confidence to your costs and protect your profits.
Interested in learning more? Fill in the form below to discuss how we can help your business scale further, faster.
10 FAQs about how interest rates affect the dollar
Below are 10 frequently asked questions relating to interest rates and their impact on the US dollar. Some include points already discussed in this article.
What happens to the dollar if interest rates rise?
Typically, when interest rates rise, the dollar strengthens. Higher rates attract foreign investment into US assets, increasing demand for the dollar and boosting its value.
Why do lower interest rates weaken the dollar?
Lower rates make US assets less attractive to investors, who may seek better returns in other currencies. This reduces demand for the dollar, weakening its value.
How do interest rates affect US exports?
Higher interest rates can strengthen the dollar, making US goods more expensive for foreign buyers and potentially reducing exports. Conversely, lower rates and a weaker dollar increase export competitiveness.
Why is the dollar’s strength important for businesses?
The dollar’s value impacts import costs, export revenues, and the competitiveness of businesses in global markets. Changes in its strength can directly affect profit margins.
How does a stronger dollar impact emerging markets?
A stronger dollar increases the cost of repaying dollar-denominated debt in emerging markets, potentially leading to economic slowdowns in these regions.
What role does the Federal Reserve play in the dollar’s value?
The Federal Reserve sets interest rates, which influence the dollar’s strength by impacting investor demand for US assets and controlling inflation.
How can businesses protect themselves from dollar fluctuations?
Businesses can use foreign exchange (FX) hedging strategies, such as forward contracts, to lock in favourable rates and manage currency risk.
Does a weaker dollar benefit the US economy?
Yes, in some cases. A weaker dollar boosts US exports by making goods and services more affordable for foreign buyers and can attract international tourism and investment.
What is the US Dollar Index (DXY), and why is it important?
The DXY measures the dollar’s value against a basket of major currencies. It serves as a benchmark for understanding the dollar’s relative strength globally.
How will Donald Trump’s policies affect the dollar?
Trump’s pro-business stance and potential trade tariffs may initially strengthen the dollar by increasing investor optimism. However, inflationary pressures or fiscal deficits could weaken it over the long term.
This article is for information purposes only and should not be regarded as any financial advice.
