A currency exchange rate is one of the many factors to determine a country’s economic standing on an international level. Inflation, Gross Domestic Product (GDP), monetary policy and balance of payments affect currencies the most. The Federal Reserve’s monetary stimulus has not only helped the U.S. economy get back on its feet but has also played a major role in strengthening the U.S. dollar against major global currencies such as the Japanese yen, euro and British pound. If one observes from a macro standpoint, the export and import figures of all major economies in the world have fallen. Countries have started introducing monetary stimulus to escape from recession, inviting deflation, which in turn was affecting their currency. The economic growth of countries has started slowing as their manufacturing activities and factory outputs are declining gradually. Let us consider currencies of major economies versus the U.S. dollar.
Since the start of 2013, the Japanese yen has fallen almost 18% against the U.S. dollar. Against one U.S. dollar, Japanese yen increased from 86.16 to 101.22. Of-late, Japan recorded GDP growth at 0.9%, but export and import data played a major role in determining the currency exchange rates. For the month of April, marginal increase in the exports data of 3.9% was offset by huge imports, which increased 9.4%. Another reason, which is attributable to the fall of Japanese yen, is the introduction of the U.S. monetary stimulus. Although this improved the country’s economy, it has affected the country’s currency. On one hand, this policy has increased money circulation for higher investments. However, it has created problems for itself by increasing chances of higher deflation. Another factor that has always affected the currency is the long-term deflation and continuously increasing of budget deficit. If the country is unable to control its rising fiscal deficit and deflation soon, the Japanese yen is set to face more troubles.
Technically, the eurozone crisis started with the meltdown of Greece about three and a half years ago. The affect trickled down to major economies such as Germany, France, Italy and Spain. Eurozone’s unemployment level is at a record 17% and the GDP growth has contracted for the sixth straight quarter. Successive attempts of anchoring the eurozone out of the crisis have failed. The European Central Bank has decreased interest rates to record lows but the measure has hardly affected the economic growth. If things don’t change soon enough for the region, the group will be on the same path as Japan. Deflation and fiscal deficits will soon creep in, making things worse for the Euro currency. From Jul 2011, value of one U.S. dollar in terms of a Euro increased by 11% from 0.6988 to 0.7757 in May 2013. Rate cuts and external loans might solve the region’s problem temporarily but in the long run deflation will become a threat, affecting the region’s currency. The region needs a U.S.-like model to accelerate the economy.
The economic recovery in the United Kingdom is relatively better than the eurozone but concerns linger owing to mixed numbers. The country’s economy has increased marginally and the unemployment rate has come down from 8.0% to 7.8%. In spite of the rise in employment, the average earning has been at a record low at 0.8%. This indicates that consumer spending has not increased and thus there are chances of these figures adversely affecting the country’s inflation, which in turn will have an negative effect on the currency against the U.S. dollar. The irregularity in the numbers remains a cause of concern because consumer spending drives the country’s economy. If consumer spending continues at the prevailing rate then there is a high probability that the British pound will show weakness in the future. Since Jan 2013, the U.S. dollar when compared against a single British Pound has gained about 6.8% from 0.6183 to 0.6604 in May 2013.
The value of the Exchange-Traded Fund (ETF) of the currencies in the U.S. stock market has depreciated considerably owing to the above reasons. The PowerShares DB US Dollar Index Bullish (UUP - ETF report) has increased 4.9%, while CurrencyShares Japanese Yen Trust (FXY - ETF report), CurrencyShares Euro Trust (FXE - ETF report) and CurrencyShares British Pound Ster. Trst (FXB - ETF report) lost 18%, 6.3% and 8.1%, respectively.
The strengthening of the U.S. dollar has been on the back of monetary stimulus. There are speculations that sooner or later the quantitative easing will be slowed or ended. Without doubt, there will be repercussions with the slowing or ending of the stimulus. The employment numbers, the housing market, and consumer confidence have attained pre-recessionary levels. The only glitch that remains is the inflation rate, which is still hovering around 1% with the unemployment level at around 6.5%. The question that remains is: Will the U.S. economy and the U.S. dollar stay strong enough without the monetary stimulus?