Reading the Wall Street Journal: The “Currency Trading” Column
Now that we have an understanding of how exchange rates are determined, we can use our analysis to understand discussions about developments in the foreign exchange market reported in the financial press. Every day, the Wall Street Journal reports on developments in the foreign exchange market on the previous business day in its “Currency Trading” column, an example of which is presented in the Following the Financial News box, “The ‘Currency Trading’ Column.” The column states that the dollar fell against the euro after the Federal Reserve renewed its commitment to ultralow interest rates as it turned more cautious on the U.S. economic recovery. Our analysis of the foreign exchange market explains why this development led to a weaker dollar. The weaker economy and the Fed’s commitment to keep interest rates low lower the expected return on dollar assets in the future. Therefore, traders in the currency markets will expect that in the future the relative expected return for dollar assets will be lower and, as a result, there will be a smaller quantity of dollar assets demanded at each exchange rate. Thus, they expect that in the future the demand curve for dollar assets will shift to the left, as in Figure 15.5, and the dollar will depreciate in the future. Because currency traders expect a lower future exchange rate for the dollar, the expected appreciation of the dollar falls today. This lowers the expected return for dollar assets relative to foreign assets now, which causes the demand for dollar assets to decline and causes the current exchange rate to fall, as in Figure 15.5. The column also points out that the British pound appreciated because one member of the Bank of England’s Monetary Policy Committee voted to raise interest rates. Again this is what our analysis of the foreign exchange market predicts. The greater likelihood of a rise in domestic (British) interest rates will lead traders to expect the relative expected return for pound assets to be higher, thereby increasing the quantity of pound assets demanded at each exchange rate, shifting the demand curve to the right as in Figure 15.4, and causing the pound to appreciate in the future. The higher expected future exchange rate for the pound raises the expected return for pound assets, which causes the demand for pound assets to rise today and causes the pound to appreciate as in Figure 15.4.