In terms of the price of money, decrease in the interest rate of USD means the depreciation in the value of dollar. While the interest rate for Euro is supposed to get higher, the exchange rate of Euro against USD will definitely raise a lot.
Related to the saving, since it is very probable that the FRB is going to cut its interest rate so that the people who save in US dollars will get lower return per unit period of time, many of them will decide to sell the dollar and buy other currencies with higher interest rate such as NZD. Also, many of whom making arbitrages in the Foreign Exchange market will probably decide to close their current positions, since the return will decrease due to the lowering difference between the interest rates of USD and JPY. This action will give a greater supply of USD and demand of other currencies with lower interest rate. As it is shown in the diagram below, USD depreciates against the Euro.
In the last second paragraph, the enormous US current account deficit also demonstrates that the money is shifting away from the United States. From this information, it is known that the country is importing more than exporting. Therefore, it can be analyzed that the supply of USD is rising as people or firms need to sell the USD and buy other currencies in order to import goods and services from abroad. Finally, the depreciation of USD occurs.
The declination of dollar leads to the decrease in the value of dollar-priced commodities, attracting foreign investors who hold other currencies such as Euro and New Zealand Dollar to make purchase on those commodities. Also, since the crude oil somehow has a same property as gold which can avoid the value depreciation due to the unexpected inflation or market shock, individuals and some firms would like to hold the oil futures (or gold) instead of a bulk of money during the special period like this subprime crisis. This will lead a shift in the demand of the dollar-priced commodities such as the crude oil to the right, giving an increase in the price of the commodities.
This news article also refers to the China’s exchange rate system. Although Chinese government has changed their exchange rate system from Fixed Exchange Rate to Managed Exchange Rate getting appreciation due to the outside pressure, the Europeans don’t satisfied with this replacement and still think Yuan is undervalued that affords advantages to China’s export. This is because the price of the goods in the country with an undervalued currency will be more attractive to the other countries.
Extract:
FRANKFURT, Oct. 18 — The dollar sank to a new low against the euro Thursday as fresh evidence of losses in the mortgage industry stoked fears of a sharper-than-expected economic slowdown in the United States and crude oil rose to another record.
In late afternoon trading in New York, the euro traded at $1.4294, up from $1.4186 on Wednesday. Crude oil for November delivery rose $2.07, or 2.4 percent, to $89.47 a barrel. In after-hours electronic trading, the price rose slightly above $90.
The declining dollar has made commodities, which are priced in dollars, more attractive as investments, while tensions between Turks and Kurds over border violence in northern Iraq have helped keep oil prices rising.
The dollar’s retreat came as European employers issued their clearest call yet for international action at the meeting, which begins on Friday, to curb currency market volatility. A strong euro has the potential to slow European exports, and volatility upsets plans for hedging.
BusinessEurope, the Brussels federation of employers’ associations, said in a letter to four European finance ministers that the “unduly rapid movements” of currencies were “an increasing source of concern, with the euro and other European currencies reaching historically high levels in recent months.” It also called for an upward valuation of the yuan and the yen.
Euro zone finance ministers agreed Oct. 8 to advocate for a higher yuan at the Group of 7 meeting. Officials overseeing the euro will also visit China before the end of the year to urge Beijing to revalue its currency.
After appearing to stabilize for a few weeks, the euro rose to an all-time high of $1.4310 during trading Thursday before giving up some of its gains.
Markets were rattled Thursday when reported a sharp drop in third-quarter profit because of write-downs of bad debts; poor results from investment banking, reflecting credit market turmoil; and consumer banking setbacks. That helped feed worries that the credit squeeze stemming from the housing industry’s decline would hit corporate profits and slow growth.
“It’s amazing how much these initial announcements can drive a dollar sell-off these days,” said Simon Derrick, head of currency research in London for Mellon. “That said, I think the skids were already underneath the dollar earlier this week.”
Indeed, the data continued a bad week for the United States economy, where an end to housing industry woes is not yet in sight. A government report Wednesday showed that new home construction plunged to a 14-year low in September.
New signs of weakness in the United States could lead the Federal Reserve to cut its benchmark interest rate when it meets this month, a step that might bolster the economy but would also reduce the appeal of dollar-denominated assets.
Coming at a time when the is considering when to raise rates again, this differential in rates has emerged as a main driver of the dollar’s weakness.
BusinessEurope called on the Group of 7 finance ministers and central bankers to find solutions “within the sphere of multilateral consultations, and notably with clear commitments in the G-7.” The letter was also signed by the heads of business lobbies in Germany, France and Italy. “Persistent disequilibria in the world economy continue to harbor the danger of further appreciation of European currencies in the face of large external deficits in the U.S. and inflexible currency regimes in other parts of the world,” they wrote.
The comment alluded to the enormous United States current account deficit, whose sheer size has left currency markets vulnerable to jitters that foreigners would tire of lending the cash required to cover the shortfall, a reflection of how much more Americans spend than they save.
It also referred to China’s foreign exchange management, which has kept the yuan low against the dollar.
A decrease in the value of one currency in term of another one.
(a) group(s) of investments.
Interest (or the interest rate) is the price of money (a currency).
Arbitrage in the Forex market is a type of action that traders borrow and sell currencies whose interest rates are quite low, and then buy the other currencies with higher interest rate so that they can get returns from the difference between the interest rate.
The difference between a nation's total exports of goods, services and transfers, and its total imports of them.
