What Moves Exchange Rates?

WHY CURRENCIES MATTER

The currency markets are probably the most far reaching among all asset classes. Whether individuals are impacted by the international nature of their investment holdings, owning property or businesses outside their home country or simply for vacations, the need to exchange one currency for another is pervasive.

Higher levels of inflation and interest rate rises in many major economies have caused turmoil in currency markets. We explore the drivers of exchange rates and how this might impact investors.

WHAT MOVES EXCHANGE RATES?

Currency exchange rates are impacted by a mixture of drivers affecting different exchange rates in different combinations and to different extents. It includes:

Inflation

Inflation is a measure of the rate of change of prices over time. Countries with higher levels of inflation tend to see their currencies depreciate relative to those with lower rates, as inflation diminishes the value of money.

Interest rates

Countries with higher relative interest rates can see their currencies appreciate in the short term as these higher rates of interest attract more investment.

Political and economic conditions

Political and economic stability can drive demand for a currency as a safe haven asset and thereby increase the exchange rate. Instability can reduce confidence in economic conditions and cause capital to exit a country, thereby lowering the exchange rate.

Trade and economic growth

Countries enjoying greater economic growth will tend to see their currency appreciate. Commodity exporting countries may also see a gain when global economic growth increases, raising demand for their core exports. In general, those countries that export more goods and services than they import should have well supported currencies compared to those where the opposite holds true.

Exchange rates represent the rate at which one currency can be exchanged for another. As such, the above factors should always be considered on a relative basis comparing the two currencies in question.

Trade and economic growth

Countries enjoying greater economic growth will tend to see their currency appreciate. Commodity exporting countries may also see a gain when global economic growth increases, raising demand for their core exports. In general, those countries that export more goods and services than they import should have well supported currencies compared to those where the opposite holds true.

Exchange rates represent the rate at which one currency can be exchanged for another. As such, the above factors should always be considered on a relative basis comparing the two currencies in question.

THE IMPACT OF CURRENCY EXPOSURE

Most investors will face multiple areas of currency exposure across their investment portfolio, any foreign businesses or property holdings, as well as day-to-day expenses.

Currency exposures are a driver of financial returns, and in the case of significant exposures – from either assets or liabilities – it can pay to understand these risks and take appropriate measures to mitigate them, should this be desired.

Where liabilities are concerned - for example foreign business expenses, mortgage payments or foreign school fees - a simple approach to reduce currency risk can be to match currency holdings closely to liabilities. For investment holdings, the currency exposures of an internationally diversified portfolio may represent a desirable additional source of return for some investors, or alternatively, currency exposures may be explicitly reduced via hedging for those wishing to remove this risk.

Whatever your currency concerns, your Relationship Manager is here to help.