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Dollar back. Fed moves FX market, too

By Dr. Don Taylor ·
Tuesday, March 25, 2014
Posted: 6 am ET

Fed Chair Janet Yellen's first press conference created a bit of a stir when she put parameters on when the Federal Reserve Board may start raising short-term interest rates. I'll admit to only listening to part of the press conference. It wasn't her remarks, but the reporters' offbeat questions as the conference progressed, that had me press the mute button.

Regardless of intent, her comments moved markets, with both the U.S. stock and bond markets trading off on the day. What really got my interest, however, was the impact her comments had on the currency market. U.S. retail investors tend to not pay attention to the effect of currency markets on economic growth. Maybe they should. A stronger currency, in general, makes it harder to export goods.

Impact of exchange rates

I've been following currencies more closely since I began teaching a course in International Finance. I even traded currencies alongside my students in a trading simulation this winter. Despite the developing scandal in currency trading, where traders allegedly have colluded to move markets (not unlike the manipulation of LIBOR from a few years back), I believe that getting a feel for currency markets, even without actually trading those markets, can help investors gain an understanding of the impact of exchange rates on their investment portfolio.

Governments looking to increase economic growth will seek to weaken their currency to make it easier for their manufacturers to export goods. Japan has stated that goal outright. Other countries, seeking to protect domestic sales and their own exports, take countermeasures to weaken their currency.

The dollar is showing strength, thanks to the "flight to quality" potential that I wrote about in last week's post, the Fed moving toward the eventual end of quantitative easing, and the timeline for when the Fed's Open Market Committee may start raising its targeted Fed Funds rate. The headwinds of the dollar's strength on U.S. unemployment, economic growth and the balance of trade will play out over time, but since the markets are forward-looking, they're discounting this information to arrive at today's prices.

A strengthening dollar can point toward economic growth in other markets. Will it get you to change your asset allocation in foreign markets?

Follow me on Twitter: @drdonsays.

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