As a continuation of our first part series, U.S. Dollar, Down and Out, or Not to Worry? (Part One of A Series) we will expand on interest rates and their direct effect.
Given the fact that, using our Bank of England example, certain governments have different objectives that others, (U.S.) Let’s take a look at the possible direct effects, again in our opinion.
The U.S. Government is attempting to stimulate our economy by holding rates low. without much consideration to the level of the U.S. dollar against other foreign currencies. This helps the ailing housing market and also helps the financial centers, banks, become more profitable. Low interest rates help home owners refinance and purchase homes at a much more affordable monthly payment. Low interest rates are very profitable for financial centers as they loan at much higher rates than they borrow or lend at, thereby putting the wind at their back for profits.
The unintended consequence of lower rates, again in our opinion, is a lower U.S. dollar. Currency investors rush to borrow from lower rate countries, extracting cash, and lend or invest funds in the higher interest rate currency, also known as the “carry trade.”
Our belief is there is an approximate finite pool of currency investors, and as disparity between country rates exist, the lower interest rate country currency will be pushed down, and the higher currency interest rate moved up, all other factors being equal.
Next up, in our last part, longer term patterns.