3-Month ESTR Mar '25 (RAH25)

Description

A "currency" rate involves the price of the base currency (e.g., the dollar) quoted in terms of another currency (e.g., the yen), or in terms of a basket of currencies (e.g., the dollar index). The world's major currencies have traded in a floating exchange rate regime ever since the Bretton-Woods international payments system broke down in 1971 when President Nixon broke the dollar's peg to gold. The two key factors affecting a currency's value are central bank monetary policy and the trade balance. An easy monetary policy (low interest rates) is bearish for a currency because the central bank is aggressively pumping new currency reserves into the marketplace and because foreign investors are not attracted to the low interest rate returns available in the country. By contrast, a tight monetary policy (high interest rates) is bullish for a currency because of the tight supply of new currency reserves and attractive interest rate returns for foreign investors.

The other key factor driving currency values is the nation's current account balance. A current account surplus is bullish for a currency due to the net inflow of the currency, while a current account deficit is bearish for a currency due to the net outflow of the currency. Currency values are also affected by economic growth and investment opportunities in the country. A country with a strong economy and lucrative investment opportunities will typically have a strong currency because global companies and investors want to buy into that country's investment opportunities. Futures on major currencies and on cross-currency rates are traded primarily at the CME Group.

Dollar - The dollar index (Barchart.com symbol DXY00) traded sideways in the first half of 2023 and was supported by the Federal Reserve's hike in its federal funds rate target range by +25 bp at the February, March, and May policy meetings. Sticky US price pressures and a strong labor market kept the Fed hawkish, with the January CPI rising by +6.4% yr/yr, well above the Fed's 2% inflation target, and the April unemployment rate falling to match a 54-year low of 3.4%. In addition, a crisis in US regional banks boosted safe-haven demand for the dollar after Silicon Valley Bank collapsed in March, the biggest US bank failure since 2008. However, the dollar weakened in June and July, posting a 1-3/4 year low. At its June meeting, the FOMC kept its federal funds rate target range unchanged at 5.00%-5.25%. Inflation pressures abated and weighed on the dollar after June CPI eased to +3.0% yr/yr, the smallest increase in 3 years. The Fed then paused its rate hike cycle after raising the fed funds target range to the cycle high of 5.25%-5.50% at the July FOMC meeting. However, the 10-year T-note yield rose to a 16-year high of 5.019% in October, pushing the dollar index up to 1-year high of 107.348. The dollar index retreated into year-end after the FOMC at its December meeting signaled a pivot to rate cuts in 2024. The dollar index finished 2023 down -1.9% yr/yr at 101.333.

Euro - EUR/USD (Barchart.com symbol ^EURUSD) ratcheted higher into mid-2023 and posted a 2-year high of 1.1275 in July. The European Central Bank (ECB) in 2023 raised its deposit rate by a total of 200 basis points to a record high of 4.00% in September, 2023. Sticky price pressures kept the ECB hawkish into Q3 of 2023 as the Eurozone CPI in September eased to only 4.3% yr/yr, more than double the ECB's 2% price target. However, the euro fell to a 1-year low in October as high interest rates hurt the Eurozone economy. Eurozone manufacturing activity in July contracted by the most in 3-1/2 years, and Eurozone real GDP in Q3-2023 fell to zero growth year-on-year from +0.6% yr/yr in Q2. The euro recovered into year-end after ECB President Lagarde at the October ECB meeting said talks of ECB rate cuts "are totally premature." The 10-year German bund yield climbed to a 12-year high of 3.03% in October, boosting the euro. EUR/USD finished 2023 up +3.1% yr/yr at $1.1038 per euro.

Yen - USD/JPY (Barchart.com symbol ^USDJPY) posted a 1-1/2 year low of 127.23 yen per dollar in January. The yen had support in early 2023 on speculation the Bank of Japan (BOJ) was close to exiting its negative rate policy. The BOJ, at its July policy meeting, widened its yield-curve-control and raised the upper limit of its 10-year JGB yield target to 1.0% from 0.5%, which was bullish for the yen. However, the yen weakened and fell to a 1-year low against the dollar in November as the BOJ continued its large-scale bond buying program and maintained its negative interest rate target at -0.1%. Weakness in Japan's economy dampened expectations that the BOJ would end its bond buying and negative interest rates after Japan's Q3 GDP fell -3.3% (yr/yr annualized), the steepest pace of contraction in 3 years. The yen then strengthened into year-end on weakness in the dollar when the Federal Reserve in December signaled a pivot toward cutting interest rates. USD/JPY finished 2023 up +7.6% yr/yr at 141.03 yen per dollar.

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