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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) posted the low for 2022 of 94.629 in January. The dollar then rallied steadily into Q4 of 2022 as the Federal Reserve tightened monetary policy aggressively. The Fed raised the federal funds rate target by 75 basis points at its June 2022 policy meeting, the biggest rate hike since 1994, to combat soaring inflation. U.S. June consumer prices rose at a 9.1% yr/yr pace, the most in 41 years. Also, global geopolitical risks fueled demand for the dollar as a safe haven after Russia invaded Ukraine in February. The Fed continued to raise interest rates aggressively, hiking the federal funds target range by 75 basis points for four consecutive FOMC meetings up to 3.75%-4.00% at the November meeting. The dollar index continued higher and posted a 20-year high of 114.778 in late September. The surge in U.S. bond yields during 2022 to a 15-year high of 4.34% in October strengthened the dollar's interest rate differentials and supported the dollar. The dollar then fell back into year-end as the Fed began to slow its pace of rate hikes, raising the federal funds target range by only 50 basis points at the December FOMC meeting. Also, speculation increased that the Fed was close to ending its rake hike campaign as the U.S. CPI slowed to a 14-month low of +6.5% yr/yr in November. In addition, Fed Chair Powell at the December FOMC meeting said that policy was "getting close" to a sufficiently restrictive level. The dollar index finished 2022 up +8.2% yr/yr at 103.522.
Euro - EUR/USD (Barchart.com symbol ^EURUSD) posted the high for 2022 of 1.1495 in February. However, Russia's invasion of Ukraine in February 2022 sent EUR/USD tumbling through Q3. The war in Ukraine pushed energy prices sharply higher, causing concern about an energy crisis and the Eurozone economy. European natural gas prices surged to a record high in March after Russia threatened to cut off natural gas flows to Europe in retaliation for sanctions the European Union imposed on Russia for invading Ukraine. Roughly 40% of European gas imports were from Russia prior to the war. EUR/USD trended lower and posted a 20-year low of 0.9536 in September. However, surging consumer prices in the Eurozone forced the European Central Bank (ECB) to tighten monetary policy, sparking a recovery in EUR/USD. Eurozone consumer prices jumped to a record high of 10.6% yr/yr in October, prompting the ECB to raise its deposit rate during 2022 by a total of 250 basis points to 2.00% by December. That boosted European government bond yields and strengthened the euro's interest rate differentials. EUR/USD finished 2022 down -5.8% yr/yr at 1.0705.
Yen - USD/JPY (Barchart.com symbol ^USDJPY) posted its low for 2022 of 113.49 in January. The yen found support in Q1 2022 on safe-haven demand from global geopolitical risks after Russia invaded Ukraine in February. However, a surge in global inflation caused the Federal Reserve, the Bank of England, and the European Central Bank to end their quantitative easing (QE) programs and raise interest rates. The divergence in global central bank policies hammered the yen as the Bank of Japan (BOJ) boosted its QE program and maintained record-low interest rates. As a result, USD/JPY rallied sharply into Q4 and posted a 32-year high of 151.95 in October. USD/JPY reversed into year-end as the yen strengthened after the BOJ intervened in the currency market to support the yen. The yen also received a boost after the BOJ, at its December meeting, adjusted its yield-curve-control (YCC) program and raised the upper band of its 10-year yield target range to 0.50% from 0.25%. USD/JPY finished 2022 up +13.9% at 131.12.
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