interest rates and dollar depreciation

why does the dollar depreciate when the interest rate is lowered? is it because there is less foreign demand for the dollar since the return on the loans is lowered?

less demand for US dollars… think about it, if you can buy a UK Gilt for 8% coupon or a US Tsy for a 4% coupon what are you going to buy? bigger picture – if interest rates keep getting cut obviously there are macro-economic problems in the US, so people shy away from putting their $ there

They tricky part is when rate hikes or decreases are already priced into the market prior to the announcement, which is most of the time. That is why sometimes you see the opposite happen on announcement days. Or the market reacts to any hints of future decisions.

The dollar depreciates when rates go down because it makes more sense to seek higher returns elsewhere. Theoretically, if all rates were to decline the same percentage amount in one day, there shouldn’t be any impact on currencies. Another example is if a soverign nation has a fairly small market in gov’t debt the impact should be smaller on rate changes. Right now foreigners own quite a bit of USG debt and foreigners move money around the globe to maximize their returns. At some level lower than here in the dollar rate changes will not have as large an impact as the cost of comparable goods overseas will outweigh changes in rates. In other words we are much closer today to a level where a car can be produce here and exported more cheaply than it can in the eurozone. So dollar demand will pick up as long as we can export. That statement couldn’t be said when the dolar was one to one with the Euro.

its great that we can send cars to europe but we cant go on vacation to europe!

The direction of the exchange rate change has already been explained above. The magnitude of it is however mainly due to speculation. The daily volume exchanged on the EUR/USD market is about the size of the annual GDP of Germany …