When a currency rises, what happens economically and financially?

Since the end of January, the US Dollar, on a trade-weighted basis, has risen 5.4%.  Historically, when you look from 1975 onward, that is a lot.  Percentile-wise that puts the current move in the top 16% of all moves since 1975.  And when you consider upside standard deviation alone, its about a 1.82 Z move, meaning it’s a pretty rare, though not entirely an outlier, event.

So what happens economically and financially when your currency goes up a lot?  If you are an island economy or very export dependent like Japan, a large upside move in your currency should be painful, because it makes your exports uncompetitive and increases your import costs.  Or………so the conventional wisdom goes.

When you look at what actually happens to domestic markets in the developed world historically, as well as what happens to industrial production when the trade-weighted currency of an economy rises 5% or more, you find two things.  First, a big jump in the currency really doesn’t impact major financial markets at all.  Stocks and bonds rise normal amounts, perhaps because the FX move is seen as a temporary effect.  By contrast, a rise in the currency does appear to actually dampen industrial production, which is what one would expect.  Put another way, large currency moves in the developed world appear to have important economic consequences, but little impact on financial markets, perhaps because the economic impact is so short-lived.

Here is what happens to industrial production in the US and among 17 other developed countries after the trade-weighted currency rises 5% or more, using data from 1975 onward.  Historically there are 87 months when the US currency was up more than 5% over a 5 month stretch, and 769 months for the other 17 developed currencies.  As you can see in the chart, US and other developed markets both experience a period of about 5 months where industrial production growth contracts, on average, modestly.


By contrast, US and other developed fixed income and equity markets are pretty much unfazed by large currency appreciations, as you can see in the next two charts.

First Bonds.

Now stocks.

Obviously a few countries are exceptional.  Australia, Norway and Hong Kong do see equity declines for several months after a large swing upward in the currency, but with the exception of Norway, every equity market is higher a year later after a currency jump.

So the next time someone tells you the large rise in the currency of a developed nation is going to make them uncompetitive and cause their markets to fall, you should probably ignore them, and go have a coffee.



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