Monday, June 23, 2014

How will rise in US interest rates affect exchange rates?

The gap between the return on US Federal government debt, called "Treasuries" (yielding 2.61%), and those of riskier European government debt, has fallen dramatically.

Now the Financial Times reports that this is attracting foreign investors to the US:
“In Europe, the risk is that the euro will depreciate,” says Scott Minerd, global chief investment officer at Guggenheim Partners. “That makes buying US Treasury bonds and other US assets attractive because the local currency could depreciate and interest rates are significantly higher in the US than in Europe.”

These investors sell Euro's to Buy dollars (to invest in US reasuries) which can be modeled as an increase in demand for dollars, which increases the "price of a dollar", or alternatively as an increase in the supply of Euros which reduces the price of a Euro. Either way, this should cause the dollar to appreciate relative to the Euro.

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