USD Exchange Rate Report: Mixed Week for the Dollar
Week of January 13 – 20, 2023
Surpise! New Content!!
Photo by Ben White on Unsplash
Welcome to the first of many Global Economics Exchange Rate Reports. These will be regular, short snapshots of trends in the US Dollar (USD) relative to major world currencies. Normally each report will include an index graph, “historical trend” graphs and a few paragraphs of discussion. They should usually be short; just 2-4 paragraphs total.
For this first report, however, I’ll take more time to explain the concepts.
The Currencies and the USD
The USD is the global reserve currency, but several other currencies are also considered “key” currencies in the world of global finance. I’ve selected six of the most commonly traded currencies: the Australian Dollar (AUD), the Canadian Dollar (CAD), the Swiss Franc (CHF), the Euro (EUR), the British Pound (GBP), and the Japanese Yen (JPY).
In all cases, I’ve quoted the currencies in US Dollars. That is, they tell you the USD dollar price of 1 unit of that currency. For example, currently it costs $1.09 to buy 1 Euro, $1.24 to buy 1 British Pound and $0.01 (“one penny”) to buy 1 Japanese Yen.
Major Currency Indices
That each currency costs a very different amount of USD makes it hard to plot everything in one graph. To get around this problem, I create an index.
Source: Yahoo Finance and own calculations. Exchange rates are inverted to be USD per local currency (i.e., an increase indicates a stronger domestic currency). They are indexed to 100 at the start of the period.
In the graph above, the first day of the week establishes the base value of 100 for the week’s index[1]. This has three huge benefits.
First, it scales everything to fit in one graph. Everything now starts at 100 and moves up and down over the week from there.
Second, if you only compare things to the beginning of the week you can read the percentage changes directly. For example, this week, the green line (GBP) rose from 100 to nearly 101.5. That’s almost a 1.5% increase over the week. The gray line (AUD) fell close to 99, which is nearly a 1% decline over the week. As long as you compare to day 1’s value of 100, you can read these numbers right off the graph as percentage increases or decreases.
These two benefits combine for the third, and main, benefit: you can see it. You don’t need computers or calculators or anything. Anyone can read it. Clearly the green and orange lines went up by more than 1% over the week while the red and gray lines fell by less than 1% over the week.
The index is visual, easy to interpret and allows us easily to compare across currencies that may be very different in value.
It’s all about the “Value of the Dollar”
The way I’ve written exchange rates, it’s always in terms of how many dollars it costs you to buy one local currency unit. Imagine walking into a store and there are little baggies of “1 foreign currency” hanging on the wall. If you check your favorite baggy of currency every day and see that the price of, say, baggy #1 rises every day, that means you have to pay more and more dollars to buy baggy #1. You’d say “that foreign currency” is getting more and more valuable (i.e., expensive). If you have to pay less dollars over the week, you’d say that it had become less valuable (i.e., cheaper) over the week.
So, I constructed the exchange rates here to be little baggies with USD prices on them. That is, “USD per domestic currency” in the same way the price of candy in the store is USD per bag of candy. When it goes up, the thing you are buying is considered more valuable. When it goes down, less valuable. Very intuitive.
We will often note, the less intuitive but equally true interpretation, that when the USD price rises for a currency that also means that the USD is less valuable (in terms of it’s purchasing power of that currency). If this is confusing, just think of inflation. If the price of things you buy goes up and up all the time, actually what’s happening is that the dollar you are buying them with is losing value (in terms of the goods they purchase). Same thing here. It’s just a little less obvious and intuitive, but still true.
Interpreting the Index
Interpreting the index is therefore pretty straightforward. Based on our latest index, over the past week, we see that the Japanese Yen (purple), British Pound (green), and Swiss Franc (orange) all strengthened relative to the US dollar over the week.
Next, we can see that the Euro (blue), Australian Dollar (grey) and Canadian Dollar (red) all weakened relative to the US Dollar over the week.
Simply put, about half the key currencies gained strength against the US Dollar and about half weakened relative to the US Dollar. And there’s not a clear geographical trend at all if you look at what rose and what fell.
Because I’ve been watching these in recent weeks, this is actually a little surprising to me because the US Dollar has been weakening against most currencies – including these – in recent weeks and months. They were all rising in last week’s graph, for example.
And that’s why I added the next piece to these reports… for a little context.
Historical Trends
Source: Yahoo Finance and own calculations. Exchange rates are inverted to be USD per local currency (i.e., an increase indicates a stronger domestic currency).
(Chris Note: “Ha ha! I will try to fix this graph going forward so the middle two graphs don’t get squished!”)
These graphs look at each currency separately over the last three months. Notice their y-axes. They are all very different. Recall, the exchange rates I report are all the “USD sticker price” to buy a currency. Those y-axis values are how many USD to buy one unit of that currency.
You don’t have to be an economist to see the clear trend that, since November, their sticker prices have all been rising. That is, they have all gained strength relative to the US Dollar (i.e., they are all more expensive). Or, if you like, the US Dollar has been losing value relative to the other major currencies in the world.
The other feature of these historical trend graphs is that the mean and standard deviations have been included. The mean is just the average of this exchange rate over the last three months. But nothing stays at its average, they all move around constantly. So we need something to put “move around” into perspective. Did the value move “a lot” or “a little”. The standard deviation helps determine “a little” or “a lot”.
Standard deviations are just what the name describes: they show how much these standardly (or typically) deviate from their average values. The upper dotted line is +1 standard deviation and the bottom dotted line is -1 standard deviation. Those just help put things in perspective.
To see that, look at the USD to the Japanese Yen in purple in the bottom right. It has risen from below its lower bound to over its top bound, slowly crawling its way up over the last three months. That’s a very clear growth trend.
We see that with pretty much all of them but the USD to the Canadian Dollar (red line, upper right panel). You can see that it strengthened a lot early, shooting from below its lower bound to above its upper bound in a matter of weeks but then fell back toward the average before rising again in recent weeks.
What’s the point?
The reason I’m generating these reports is so that I can start watching all of these things in real time again. I used to have my InvestCEE team generating these. Now I have the new team doing it. Watching these over the coming weeks and months helps me with insights into what’s happening in the global economy. And, I wanted to share them with my readers and also build some deeper reports based around these concepts.
No one other than traders and investment advisors have time to watch this stuff constantly across 10 different monitors. And I don’t trade/invest anything anyway. But I find these graphs simple and informative. I hope you do to.
What moves exchange rates?
Interest rates and expected future inflation rates drive foreign exchange rate movements a lot. But that “expectations” part is tricky. Expectations can change on a dime, based on spurious and fleeting news and so on. That should wash out quickly. It might drive things a day or two, but shouldn’t for three months. Over three months, interest rates and inflation along with major trade flows ought to drive currency movements.
In theory, if no one else had raised interest rates in the world in 2022, then as the US Fed raised interest rates, that would have encouraged people to invest in US assets to capture higher returns (due to higher interest rates). All else equal, that would have increased the value of the US Dollar relative to all other currencies. Those currencies would all have fallen in these graphs as they lost strength.
That kind of happened for the first 9-10 months of 2022, especially for the USD price of Euros. Historically, one Euro cost a little more than one US Dollar. But the ECB was slow to raise interest rates last year while the US was quicker and, sure enough, the USD price of a Euro dropped below $1.00. But, since the ECB has been catching up in recent months, the Euro has regained much of its initially lost strength. We see that in the historical graph.
Canada, however, also started raising interest rates in March (i.e., early, like the US). I would therefore have expected that the CAD lost less value relative to the USD over the year and stayed closer to its average value, in general.
But that doesn’t explain why the UK currency looks similar to the Euro. The UK also started raising rates early. Actually, the British started raising rates before the USA, in January/February while the US only started in March.
Furthermore, the Japanese only started - or are considering - raising rates now, yet their graph also looks similar to the Euro, AUD, GBP and so on. Only the Canadian currency looks a little different.
These are mysteries. And that’s why we want to watch currencies. As I commented elsewhere (see “Global Inflation to Start 2023”), the US is nearing the end of its interest rate hiking cycle. It will raise a little in the coming months then likely hold rates constant. Other countries – namely Europe and Japan – are only starting now, so to speak, and will likely be raising in 2023. That should strengthen their currencies relative to the USD. But other forces will also be at play.
As the world slips into likely recession, for example, the US will still be a safe haven for business and investment. The USD’s value relative to other currencies could strengthen as investors move money into the safe USD. And that is why I also included the Swiss Franc, CHF, which has also been a historically safe currency during finically troubling times. It will be interesting to see how it performs relative to the USD as things become more turbulent.
Future currency reports will be short. I expect 2-4 paragraphs long, not much more. But the information will help inform my other columns and reports and I hope it’s of value to all my readers. Let’s watch these trends together.
Enjoy.
[1] Technically, I take the first day’s exchange rate, divide it by itself and multiply by 100. This makes 1*100 which is, of course, 100, our base value Then I hold the first day’s exchange rate constant as the denominator and divide each day’s exchange rate by the first day’s exchange rate and multiply by 100. This gives me the value every day relative to the start of the week.