2020/08/17

Relation between country's economic growth [stock & bond market / interest rate] and currency value.

Keynesian theory
Keynesian theory introduced the concept of marginal import-oriented, explaining that if a country's economy continues to grow relatively high, it would increase imports, resulting in trade deficit and devaluation of its currency (over-demand of foreign currencies). Such external expenditure will adjust in trade balance and later on affects in the currency rate.

Global economic growth

However, as global financial market developed, things became different. If the country's economy records higher-than-expected growth, there are three factors of movements of one's currency.

Stock market
First, when the country shows how healthy its economy is, then the stock market is likely to surge. For example, after the Trump's election as 45th president of United States, the company's growth in S&P 500 stands since financial crisis 2008. Tax cut has made the company more profitable, and investors were eager to secure dollars to buy shares, funds, and securities.

Policy rates
Second, the country's market expects its interest rates to rise in the future due to an increase in confidence of its healthy economy. After taper tantrum, Janet Yellen, the former chairperson of FED, started raising up the FFR(Federal Funds Rate), which made US dollar stronger. In fact, U.S dollar was already strong as investor anticipated the FED will likely to hike the rate after austerity in QE. Investors will change their foreign currency into US dollar for their bank depository, since U.S. policy interest is higher globally.

<The more increase in FFR means the more economic growth U.S. have>

Bond investments
Third, when the economy of a country is pretty stubborn, then the government bond (or municipal bond) will probably be safe. Treasury bonds, notes and bills represent the credit of a country. In judging a country's credibility, it's important how much it grows, but it's also important how low the likelihood of bankruptcy is and how stable it is.  Asset management company such as GPIF(Government Pension Investment Fund) in Japan or Blackrock will likely to invest on safe assets such as securities which have above grade A, due to diversification of its portfolio, which will make more demand in the country's currency.
<This graph explains U.S. Dollar movements in correlation and against stock market and policy rate.> 

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