Wednesday, February 22, 2017

Ruble is up 11% since the rate cuts last June. I said to buy it back then.

The ruble is up 11% since the rate cuts last June. I said to BUY THE RUBLE at the time. By the way, an 11% move in currency markets is big.

Rate cuts are bullish for currency, all else equal. People don't understand that, yet we see it over and over again.

Rate cuts are price reductions--deflationary. It literally means the currency has more purchasing power. It's reflected in forex markets as a higher exchange rate.

Rate hikes are the opposite. They are bearish, not bullish. Rate hikes are price increases and that means the currency buys less, not more. It's reflected in forex markets as lower exchange rate.

Another way to think about it is, a currency is like a government security of zero maturity. Everyone understands that when the central bank raises rates the PRICE of the government security (a Treasury, for example) goes DOWN. Price is inverse to the rate. The discount to "par" reflects the interest rate. 

Conversely, when the central bank cuts rates the PRICE of the government security goes UP.

Same with currency. The dollar is a Treasury of zero maturity.

1 comment:

The Rombach Report said...

Nice call Mike, and of course I agree with you that all else being equal a rate cut corresponds with a stronger currency. However, I don't think it is necessarily that way all the time. Near term, rate increases can trigger demand for the currency as appears to have been the case with the dollar since the Fed has been raising rates. Longer term, higher interest rates, specifically higher US Treasury yields translates into a bigger supply of dollars as coupon payments flow through the system, which should translate into dollar weakness.