International Currrencies Made EZ: Chapter 9

by | Feb 12, 2000 | Archives, DO NOT USE - MC

* WHAT TO DO NOW: Learn short term currency factors. In this lesson we continue our review of why currencies move and look at some of the short term factors that make currencies move. See page two. 

* EZ CURRENCY DIVERSIFICATION: Find currencies with high real returns rather than just high interest rates. Real returns are the amount of purchasing power that your investments gain. Once you know how to calculate real returns you will be in a position to analyze whether a high interest rate is a good deal or not. Learn about this on page eight.

* EZ CURRENCY GUIDE: Learn how to calculate currency parity and currency interest rate velocities on page ten.

Magic moments of sunset paint shafts of orange and salmon on crystal wavetops. Evening mists veil a lemon sun that sinks near the horizon, then suddenly rises and starts another day. The dusk’s desire gives way to sunrise. Day’s end and dawn become one. The beginning and end – end and beginning, they become the same. Time stops and for an instant everything stands still.

July 1990, many miles north of the Arctic Circle-aboard the good ship, Finnmarken in the Land of the Midnight Sun. The time is seventeen minutes past midnight and the weather is warm, the night is like day.

Merri and I, with our son Jake, are taking a cruise along the coast of Norway. We have just left Berlin which we visited for unification day and on the way we had stopped in Copenhagen to meet bankers that specialized in lending currencies with low interest rates so the loans could be invested in currencies that have high rates.

We learned on that trip much about the short term factors that affect the value of currencies. In this lesson we will focus on these short term factors and the importance on their impact on your currency and all others. But before we look at these short term factors I want to share a thought I had on that trip about the nature of currency moves.

On that summer trip above the Arctic Circle, the sun never set. At dusk, the sun would sink near the horizon and then rise again to start another day. While viewing one of these incredible sunset-sunrises, I was struck with the way currency values are motivated much in the same way.

Fundamentals of astronomy cause the sun and the earth to move, just as economic fundamentals cause money to rise and fall. These fundamentals are steady, strong and in the long run totally dependable. The sunrises and sunsets eventually move exactly to the beat of fundamental forces.

But short term factors make every sunrise and sunset different, unpredictable. One day the sky turns orange, the next day grey. Often dusk and dawn are obscured by clouds or rain. Short term factors can obscure the true value of money just as the mists can make a sunset hard to see. We learn about short term currency factors next page.

Short-Term Factors of Currency Movement

If we look at the value of the U.S. dollar versus the German mark, we can see that in long term fundamentals are causing the dollar to fall. The fundamental direction of the dollar versus the German mark is down.

We can see this long term downward move in the chart below. However we can also see that at times the dollar has risen, such as from 1980 to 1986.

These temporary moves against the fundamental trend are caused by short term currency factors which include:

Interest Rate Differences
Real Returns
Velocity & Technical Trading Factors
Money Supply

Here we look at these short term factors in more detail.

* Short-Term Factor #1: Interest rate differences. A country can borrow only if its treasury issues are attractive on a global scale. Take, for example, a German investor in 1985 who bought a $10,000 U.S. dollar Treasury bond that would mature ten years later in 1985. We can see from the chart above that in 1985 it took about 2.8 German marks to buy one U.S. dollar. That German investor had to spend 28,000 German marks to get the $10,000 for the bond. When the bond matured in 1995, the dollar bought only 1.4 German marks. This means that the $10,000 now pays back only 14,000 German marks. The German investor lost 50% of his investment in the capital value of the bond!

Having seen this example and having seen in the chart the real loss in value of the dollar, we must ask, why would the German investor ever want to buy a U.S. dollar bond?

The answer is that the investor will have to be tempted to take the currency risk by a sufficient interest rate. Assuming that U.S. dollar bonds paid 7% per annum when the investor decided to buy and at that time the German mark bonds only paid 4%. Then the 3% interest differential was the main reason why the German investor decided to buy the bond. The other reasons would be the desire for diversification and a chance for a currency profit because at the time the bond was purchased the investor obviously did not know that the dollar would fall so far.

To make bond issues, in any currency, attractive, interest rates need to be competitively high versus interest rates in other currencies. Generally raising interest rates increases the strength of a currency because it attracts foreign investment and thereby causes a greater demand for the currency on international exchange markets. Also, raising interest rates slows the internal economy, tending to reduce industrial production and slow the rise of prices and reduce inflation.

A government uses interest rates to attract foreign investment to debt offerings and to establish industrial activity and price levels internally. Therefore, generally speaking, when the interest rate on a country’s new debt offerings is high, the currency is quite often weak. The high interest rates are offered to attract foreign investment, which needs incentive in order to be interested in a fundamentally weak currency.

For instance, why would an Swiss investor, whose currency (the Swiss franc) is fundamentally much stronger than the U.S. dollar, be interested in purchasing U.S. treasury certificates? The investor has to realize that over time it is quite likely that the dollar will fall in relationship with the Swiss franc and that a forex loss will be sustained. In the last year alone, the dollar has fallen 7.5% against the franc. The only incentive the U.S. government can give is to offer a higher rate of interest than could be obtained by investing in the Swiss franc. The 30 Year U.S. Treasury Bond offers just over 8% yield, while Swiss long- term bonds are at just over 5.5%.

* Short-Term Factor #2: Inflation. Perhaps the best way to spot weakness in a currency is to look at a country’s internal inflation trends. We learned in earlier lessons that a currency that is inflating will tend to fall in value versus a currency that is not inflating. These days most currencies have some rate of inflation. If the inflation rate of a currency is higher than the inflation rate of another currency, the currency with the higher inflation will tend to lose value versus the other.

In regard to spotting future inflation trends, let’s review some fundamentals we’ve already discussed.

First, we described in previous lessons how the U.S. Federal Reserve attempts to control inflation by adjusting interest rates. As you’ll recall, when the Fed fears that inflation is rising, it raises interest rates, thereby making the cost of loans higher and slowing borrowing by businesses and private individuals. When borrowing is slowed, businesses cut back on production and private individuals cut back on spending (purchasing via credit cards, mortgages, car loans, etc.) As a result, the price of goods is held in check, and inflation is held under control.

What does this show? That in general, rising industrial production in a country is a sign that prices (inflation) will rise. Dropping industrial production is a sign that prices will drop. As an aside, it should be noted that in many countries the population is growing extremely rapidly. Growth in the United States and industrial European countries is less than 3% per annum, but in many developing countries growth is over 10% per annum. This rapid growth causes consumer demand from this growing population to outstrip production potential. The result? Increased demand for a smaller number of goods, rising prices, and rising inflation. Take into account also that many developing countries have inefficient systems of production and distribution. Thus, as the population grows, production growth is spotty, further stimulating inflation.

Case Study

Published reports are available showing production rates for every country. The following reproduction is of the Economic and Financial Indicators from The Economist. These indicators include valuable information about inflation and real returns on investment. The following reproduction is from a past issue of The Economist Magazine.

The Economist sells for $3.50 at newsstands. Often the magazine makes introductory offers for 30 weeks at $54.50 (48% off the cover price). You can obtain subscription details from The Economist, PO Box 58510, Boulder, Colorado, 80321-8510, USA. Or call (800) 456-6086.

In the sample from the magazine shown last page, the first section, entitled OUTPUT, DEMAND AND JOBS, shows indicators about the economy of leading industrial nations. This section shows if a country’s economy is picking up or slowing down — hence indicating inflationary trends. In this sample, for instance, you can see that Britain’s Industrial Production (second column) over the past year has been strengthening (+3.9%). In the last three months, it has been picking up even more strongly (+5.3%). This indicates inflation potential. Germany, the largest country economically in Europe, has had an increased annual Industrial Production rate of 1.6%, indicating only modest growth and modest inflation potential. Germany has grown rapidly over the last quarter, however, (7.4%), showing that its production rate needs to be watched in the near future for developing inflation trends.

From July 1994 until mid 1995 the German mark strengthened greatly versus the British pound. This parity shift was caused in part because of inflations fears.

We can see that every country on the list, except Japan, has been in a time of increasing industrial production over the past year.

It is also worth noting that from 1994 until mid 1995 (when this course was completed) the yen rose in value versus every other currency in the world!

We can also see that several countries had been experiencing moderate growth, such as Belgium (+0.1) and Austria (+1.5). Some had experienced extreme growth, such as Sweden (+11.5) and Italy (+6.7). The United States had experienced a rather strong +5.8% growth.

Rising Industrial Production is a sign that inflation will rise.

In the period of July 1994 until May 1995 currency strengths moved almost exactly in line with the industrial production rates. In others words, the U.S dollar with the highest industrial growth was the weakest currency over the nine months. Sweden and Italy were also very weak (but not as weak as the dollar). The Belgian franc was much stronger.

Fast rising GDP (Gross Domestic Production), shown in column one and Retail Sales Volume, shown in column four are also signs of inflation. The U.S. in the sample from the Economist last page had a GDP increase of 3.8% over the last year, with an increase of 6.0% in Retail Sales. This indicated continuing inflation potential for the United States.

Unemployment figures are also long term indicators of inflation. If there is rising unemployment, chances are that wages will not rise (we will see later how rising wages affects inflation). If unemployment is low and falling, chances are increased that wages will start to rise and add to inflation.

What can we learn from this Case Study? We can learn that inflation is a short term factor that can affect the value of a currency, but that investors’ attitudes are just as important as inflation itself. In the sample above the figures in 1994 indicated that inflation in the U.S. was likely. The dollar fell in part in anticipation of this inflation. However, the inflation did not appear as expected! In this real example it was not the inflation that caused the dollar to fall, but the fear of inflation.

More Inflation Facts

Another indicator that inflation is heating up in the U.S. is the falling unemployment rate (6.9% yearly in U.S., 6.0 last quarter). Unemployment Percentage is an indicator of inflation because when unemployment rises, it means industry is laying off workers and that fewer new jobs have been created. In such an economic climate, prices will tend to stabilize or fall. When the Unemployment Percentage falls, it indicates that businesses are hiring and that industrial output (and ultimately consumer prices) are rising.

Price and Wages

Price and wage increases are another indicator of potential inflation and another section in The Economist (example shown on page four of this lesson) shows the increase or decrease of Consumer Prices, Producer Prices and Wages/Earnings. These combine to further indicate inflationary trends.

Here are simple definitions of these three statistics.

Consumer Prices: Price increases or decreases for consumer products and services. This is the most current indicator of inflation.

Producer Prices: Price increases or decreases that wholesalers and manufacturers are paying for their materials. These price changes will affect consumer prices in the future and are therefore more long-range indicators.

Wage/Earnings: Increases in wages eventually lead to increases in producer prices. Wholesalers and manufacturers will see the impact of rising wages first, then consumers will see these increases reflected in consumer prices even further in the future.

In other words, Consumer Price Increases indicate current inflation. Producer Price Increases indicate inflation that will soon be with us. And Wage/Earnings indicate more long-term inflation potential.

Yen Dollar ExampleLet’s use the indicator samples from page four for a quick analysis of how the yen and the dollar might have been be viewed back in July 1994 when theses statistics were released.

Japan at that time had a low GDP over the previous year (nil) but a much rising 3 month GDP of 3.9%. Japan’s Industrial Production fell 1.3% over the last year but rose a dramatic 11.8% the last 3 months. A similar relationship is indicated in Retail Sales (-3.1% for the year, +6.9% the last 3 months). Unemployment rates had remained steady.

Responding to these pressures, Japanese Consumer Prices had risen much more rapidly during the last quarter (2.7% for the quarter, 0.8% for the year). Producer Prices, however, had fallen for the year and for three months, while Wages/Earnings had jumped sharply.

Taking these indicators as a whole, it seemed likely that Japan would experience at the worst moderate inflation (price rises) in the short- term. Producer Prices were falling, so even this moderate inflation would likely slow somewhat near-term. Accelerating Wages/Earnings increases indicated that there could be some inflationary trend later.

Therefore, the yen at that time could have been seen as somewhat weaker than it was short-term, but fairly steady near-term.

Let’s look more closely at the U.S. statistics for PRICES AND WAGES. Consumer prices were rising fairly strongly, but producer prices had risen hardly at all during that past year, and only 0.6% during the last 3 months. Wages/Earnings, however, rose 2.5% over the past year and 1.8% during the last quarter.

What did these figures indicate? That current prices (inflation) were rising fairly strongly. That producer prices did not cause great inflationary concern, but the Wages/Earnings statistics indicated that prices would continue to rise moderately-strongly.

These statistics, along with the recent increases in the U.S. interest rates, were indicators that the dollar would rise somewhat against the yen short-term. But this was not to be the case!

Investor fear caused the dollar to be looked upon worldwide as being even weaker than statistics would indicate. This fear over the dollar was based on the continuing U.S. deficit, uncertainty about government economic policies (including the looming specter of the health-care reform, which could cost additional trillions of dollars over the next decade) and ongoing concerns for inflationary trends.

It must always be remembered that currency prices are, like stocks, subject to the whims and emotions of the traders who actually bid for and purchase the currencies. The two greatest motivators for stock prices are said to be fear and greed. The same is true of currencies. Foreign exchange brokers, large banks, corporations, and wealthy individuals — all of whom make up the bulk of foreign exchange transactions — always tend to base their activities on the fear of a currency falling.

The U.S. dollar had been weak for a long time. It was not illogical at that time (in July 1994) for investors to be wary of dollar drops. Investors were afraid of the dollar which made it hard for the value of the dollar to rise. Just as in a bear stock market, when stocks of well-run and profitable companies may fall, the same is found in foreign exchange markets. The dollar was in such a situation and this resistance to strengthening was an indication of the deeper, more fundamental weaknesses of the dollar.

However, these short term factors cannot be ignored and now as this course is written it appears that the U.S. dollar has been oversold. The dollar has suddenly strengthened almost 10% in just two weeks. The short term factors have had their effect.

Important point to remember: Investor sentiment (fear of loss or desire for profit) almost always pushes currencies beyond their real fundamental values when they reach peaks of strength and troughs of weakness. Any of these peaks and troughs can be times of great opportunity but are also times of great danger for those who speculate on currency moves.

Commodity Price Index

Another section in the Economist sample on page four of this lesson is the COMMODITY PRICE INDEX SECTION. This section shows how prices of food, metals, oil and other vital goods and items have changed worldwide over the past year and the past month. These statistics do not, in themselves, give indications of inflation. They do give a general overview of price changes worldwide.

Notice that this section is divided into subsections: prices on a dollar index, a sterling index, an SDR index (SDR is a statistic based on a bundle of currencies, including the German mark and Japanese yen) and sections on gold and oil.

All prices are based on 1990 prices, which set a benchmark of 100 on the scale. In dollar terms, all items were at 121.4 on July 19, 1994 a rise of 21.4 on the index. Food in particular has soared, rising 45.3 on the index just during the last year. As recently as two years ago, food was in the 90 range on the dollar index, having dropped from the 100 benchmark of 1985.

This index shows that inflation is strong worldwide. Metals, however, have not been keeping up with increasing prices, especially gold. Watching this section can give an investor clues about inflation and clues about when it might be wise to buy (or sell) various commodities including gold.

A Picture of the World

It’s interesting that a magazine (The Economist), readily available at most newsstands and available for weekly delivery, can give such an enormous amount of valuable information.

We can use these statistics (which may seem quite dry and boring on the surface) to paint an exciting picture of what is likely to happen to the world’s currencies. Even more important, these statistics can give us knowledge about what is likely to happen to our future spending power and standard of living!

From dry statistics we can create interesting scenarios and play a most exciting game..estimating which economy and currency will be the strongest and watching to see how accurate our estimates are.

* Short-Term Factor #3: Real Return on Investment. Real returns are the earnings one makes from an investment in a currency after taking inflation in the country of that currency into account. Shown below is a list taken from The Economist’s FINANCIAL INDICATORS section, which shows the Three Month Money Market Rate of 13 major currencies. Also shown is the rate of consumer price increases in each country for the same period. From these two sets of figures, we can calculate the real return of a Three Month Money Market Investment in each currency.

             Country       3-Month       Consumer Price        Real Return                           Money Mkt.     Increase 3 Mos.       Rate 3 Mos.               Australia      5.12%            -0.8%               +5.92%               Belgium        4.85%            +0.99%              +3.86%               Britain        5.06%            +2.2%               +2.86%               Canada         5.69%            +5.8%               -0.11%               France         5.50%            +0.8%               +4.70%               Germany        4.88%            +4.4%               +0.48%               Holland        4.80%            +1.6%               +3.20%               Italy          8.63%            +4.1%               +4.53%               Japan          2.12%            -2.4%               +4.52%               Spain          7.69%            +4.2%               +3.49%               Sweden         7.35%            +2.7%               +4.65%               Switz.         4.13%            -0.1%               +4.23%               USA            4.66%            +0.6%               +4.06%

These figures above show why we have to look beyond just the earnings of a deposit, bond or share when thinking of investing in a foreign currency. We can see why we need to understand real returns to have a full understanding of the spendable profit we can gain from an investment.

If, using the example above, you were holding 3-Month Money Market Investments in Canadian dollars, you would have made 5.69% annualized rate (12 months). Dividing that percentage by 4 to determine how much you actually would have made during the 3-month period, shows that you would have made 1.42% (5.69%/4=1.42%). When you take price increases into account (+5.8% during the quarter), you would have lost 4.38% during the quarter (5.8%-1.42%=4.38%).

However, actual profits were better than they appeared in Japan. Japan’s quarterly return was just 0.53% (2.12%/4=0.53%). But since Japan’s 3-month price index was -2.4%, the actual spendable return on investment was 2.93% for the quarter (0.53%+2.4%=2.93%). Therefore, the return on investment was actually better for Japan than for Canada, although Canada’s 3-month rates were considerably higher.

If we compare Canada and Australia as an example, it appears when looking just at interest rates, that a Canadian dollar 3 month money market investment offered a better return then an Australian dollar three month money market return. However, in real terms (after taking inflation into account) Australia offers the best return of all, while Canada offers the worst.

Real Returns and Inflation Potential

Here’s how to calculate real returns from an investment in a currency. Find the paid (or accrued) earnings or growth of the investment in the currency for the period of time you wish to examine. Subtract the rate of Inflation from the country of that currency for that similar period of time. If you plan to hold an investment for three months, subtract the Inflation Rate on the Consumer Price Index. If you held an investment for six months, then subtract the Producer Price Index. If you are planning a longer term investment look at the Wage Increase Index too.

Calculating real returns for your investments in foreign currencies can help guide your investment portfolio in five ways.

Guide #1. Knowing the real return within a country helps you understand the spendable profit you have made in a particular currency.

Guide #2. Knowing the real return within a currency can help you understand the real profit you have made in your own spendable (local) currency. Once you have determined a real return in terms of a currency, you can take your local currency real-return parity into account to calculate the real return in your own currency.

Guide #3. Knowing the real returns can help you determine whether a currency will be strong or weak relative to other currencies. In the chart above, for example, we see that Canada and Italy have had (and continue to have) high inflation. Thus, both currencies will probably be weak in the long term. We also see that inflation in Japan has actually dropped. This means that the yen will tend toward strength.

Guide #4. Knowing real returns can help you choose currencies in which to invest. One of the short term factors of a strong currency is having a high real return. If a currency is weak fundamentally, but offers a high enough real return, it can be attractive short-term.

Guide #5. Real returns can help you more effectively plan your future. If you are planning your savings for the future, it is not enough to know how much “money” you will have. What you really need to know is how much “spending power” you will have. If you make your savings and investment plans based on real returns, your projections will offer a more realistic estimate of your future spending power.

Calculating Spending Power

We can use consumer price indicators to predict potential real spending power on investment. Look at the U.S. indicators as an example. Say an investor holds a corporate bond paying 7.0%. Over the last year, consumer prices have risen 2.5%. Real return is a measure of investment return adjusted for price increases (remember, we’re always talking about purchasing power or lifestyle maintenance figures). Therefore, real return for the investor is 7.0% less the Consumer Price Increase of 2.5%. The investors real return is 7.0%-2.5%=4.5%.

* Short-Term Factor #4: Velocity. The velocity of a currency measures how rapidly the currency is currently strengthening or weakening. This velocity calculation can help us measure future tendencies of strength or weakness in currencies.

A currency’s current velocity is self fulfilling because investors tend to invest in currencies that are rising in value. Thus if a currency is rising, it is more likely to continue to rise.

We can better understand what a currency’s value might do by analyzing what it has done in the immediate past.

There are many ways of determining velocities but one that is popular with many investors is to measure a currency’s history through a moving average.

Currencies can be viewed in two ways: 1) the moving average of the value versus the U.S. dollar; 2) the moving average of the interest rate change of the currency.

The moving average velocity of a currency’s changing value versus the U.S. dollar is measured by dividing the currency’s latest value (compared to the dollar) by the average of the currency’s value against the dollar.

A nine month moving average, for example, is a moving average that is calculated by taking the value of the currency once a month (on approximately the same day of the month) and adding these values together, then dividing the total by nine. The result of this division is the average value of the currency (versus the U.S. dollar).

Nine months is a time period used by many analysts because it is the time period considered the most relevant. Activity that took place longer then nine months ago has minimal impact on the current trend.

I have developed a computer program that charts a nine month moving average of 39 major currencies and observing the averages as they move from month to month gives me an excellent feel for the trends of both the interest rates of the currencies and their parities versus the U.S. dollar and other currencies.

The chart below shows how I follow the velocities of the nine month moving averages currencies versus the U.S. dollar.

CURRENCY UNITS PER DOLLAR (except British Pounds, Irish Punt and ECU)

             1994             Now   Last MO   9 Mos.    Ave.  Velocity              British Pd.     1.6236  1.5770   1.4848  1.5393   0.9581              Canadian $      1.3499  1.3414   1.3826  1.3754   0.9815              Dutch Florin    1.6910  1.7378   1.8768  1.7851   0.9437              Belgian Franc   31.04   31.92    34.40   32.70    0.9491              Deutsch Mark    1.5095  1.5515   1.6695  1.5908   0.9488              Italian Lira    1543.7  1560.0   1608.6  1576.7   0.9791              French Franc    5.1666  5.2943   5.7014  5.4428   0.9493              Japanese Yen    97.33   98.97    102.75  100.42   0.9395              Swiss Franc     1.2602  1.2878   1.4089  1.3414   0.9395              Australian $    1.3460  1.3514   1.4266  1.3707   0.9820              Spanish Peseta  125.64  128.00   136.12  131.14   0.9580              Mexican Peso    3.4333  3.4045   3.3578  3.3690   1.0191

The velocity of the Canadian $ (which has been marked in bold above for example), is found by dividing the current value (1.3499 per dollar) by the 9-month average (1.3754). Thus, 1.3499/1.3754 = .9815. A velocity of less than 1.00, means that the trend of the currency is rising versus the U.S. dollar. The lower the velocity the faster the currency has been rising versus the dollar over the past nine months. In the example above, all the currencies have been rising versus te U.S. dollar, except the Mexican peso, which has velocity of 1.0191. A velocity of more than 1.00 means that the currency parity has fallen over the past nine months versus the U.S. dollar.

In this example the Swiss franc and Japanese yen which both have the same velocity (0.9395) have risen the fastest versus the U.S. dollar over the past nine months.

The above example shows the current currency parity versus the dollar first, then shows the parity of one month ago and then nine months ago. Then it shows the average parity for the nine months and the velocity.

These figures for example show that the dollar fell against every major currency over nine months. For instance, in this example a dollar bought 98.97 Japanese yen one month ago, but currently bought only 97.33 yen. A dollar bought 1.5515 German marks one month ago, but bought only 1.5095 German marks currently.

British pounds moving averages (and Irish Punt and ECU) are always charted backward, in terms how many dollars a pound will buy. So the above chart shows that in October a pound bought 1.5770 dollars. In November it increased in strength, buying 1.6236 dollars. Because of this reversal from how currency values are normally read, velocity for the pound is found by dividing the 9-month average against the dollar by the latest value against the dollar.

Velocity can also be measured for the interest rates of currencies. We learned earlier that a rising interest rate will tend to strengthen a currency. With nine month moving averages we can compare how fast interest rates of currencies are rising.

The following chart shows currency interest rates on 3-month CDs.


             1994             NOW  Last MO   9 Mos.    Ave    Velocity              US$             5.68    5.37     3.93    4.77     1.1906              British Pd.     6.00    5.81     5.37    5.45     1.1001              Canadian $      5.50    5.18     5.81    5.74     0.9566              Dutch Florin    5.31    5.12     5.57    5.07     1.0466              Belgian Franc   5.25    5.25     6.25    5.62     0.9333              Deutsch Mark    5.18    5.06     5.68    5.07     1.0217              Italian Lira    8.68    8.25     8.37    8.28     1.0487              French Franc    5.62    5.56     6.25    5.62     1.0000              Japanese Yen    2.37    2.31     2.31    2.28     1.0408              Swiss Franc     4.00    4.00    4.18     4.17     0.9584

Interest rate velocities indicate whether a currency’s interest rate is rising or falling. The higher the velocity, the faster the rate is rising.

The above example shows that the currency with the fastest rising interest rate is the U.S. dollar. This was an indication that at the time of the example there would be short-term strength in the dollar.

In this example we can also see that the interest rate of the Swiss franc had the lowest velocity. This would indicate that the trend of the Swiss franc interest rate is falling.

Viewing nine month moving average velocities of interest rates can give subtle clues as to currency trends in several ways. A rising rate indicates that a currency, if weak will strengthen or at least stabilize.

A rapidly falling interest rate (such as the Swiss franc example above) is often a signal that a currency has been very strong versus other currencies and that the monetary authorities have been reducing the interest rate to make the currency less attractive to foreign investors and in this process reduce the strength of the currency.

We will look at such tactics in more details next lesson and continue with our review of the short term currency factors plus look more at how and why central banks adjust interest rates and in the process add strength or weakness to currency values.