Foreign Currency Rates

Foreign currency rates have been volatile of late as the simmering European debt crisis threatens to send the Euro into another tailspin. European financial ministers are meeting, again, in an attempt to push through a financing package. News reports put the size of a comprehensive rescue package at around €2 Trillion. Voters in countries like Germany and France, which will pick up much of the tab for the bailout, are angry. People demonstrating, and sometimes rioting, in Greece are unhappy with what they believe are Draconian austerity measures demanded by lenders before they will forgive and refinance Greek debt. In the midst of this ongoing drama the US dollar rises as it is seen as the ultimate safe haven currency, despite the mammoth US debt. The Yen and the Swiss franc would be rising too if their respective central banks were not dumping their currencies on the market in successful attempts to contain a too rapid rise in these currencies. Neither Japan nor Switzerland wants to see their foreign currency rates rise too high for fear of damaging exports.

The US dollar has benefited from a perception of risk throughout the world. It has also benefitted from the attractiveness of US treasury bills. Interest rates have dropped substantially making treasuries purchased a couple of months ago of the best investment available. Anyone who turned their AUD, CAD, YEN, CHF, GBP, or EUR into USD a couple of months ago and bought treasuries before rates fell is very happy right now. The US Federal Reserve has promised to keep interest rates low so as not to stifle the slowed than preferred economic recovery. So long as everyone seems to want T bills those who purchased recently will be happy. However, as the recovery gains steam (a three percent global growth rate is predicted for next year) rates will go up and T bill holders will likely fear a rise in rates and want to sell. If foreign investors not only sell T bills but convert their USD back to AUD, CAD, YEN, CHF, GBP, or EUR the dollar could fall just as easily as it has risen of late.

Foreign currency rates are determined by fundamentals and by market sentiment. Employment rates and balances of payment drive foreign currency rates. Traders watch the fundamentals in both countries in the currency pair that they trade. However, monetary policy of a nation also drives its foreign currency rates. Countries like Japan, Taiwan, South Korea, and China habitually hold reserves in US dollars. By purchasing more US dollars with their national currencies these nations hold down the values of their currencies. This is important for exporting nations as it allows them to sell to their overseas customers at more competitive prices. The down side of this policy is that these nations are accepting US dollars that are always artificially more valuable than fundamentals would dictate. When the US dollar drops in response to continued external pressure these nations see their currency reserves lose value. They are essentially paying a fee in discounted dollars to prop up their export driven economies.