How is the stock market affected by currency exchange/unemployment/interest rates?
Fyuri asked:
How do currency exchange rates, unemployment numbers, and interest rates affect the stock market?
It seems these are often in the news and how prices move on the anticipation of them.
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How do currency exchange rates, unemployment numbers, and interest rates affect the stock market?
It seems these are often in the news and how prices move on the anticipation of them.
December 16th, 2009 at 10:00 am
The stock market is a collective view on the future. While a lot of information on expectations of the future come from the past, the prices reflect opinions of the future. BP is prices today to reflect what shareholders can expect to get back in the future, everything that it has made in the past is in the past. So unemployment and interest rates all affect the returns you can expect and have a huge bearing on the stock market Digger
December 17th, 2009 at 9:57 am
This is an interesting question, and I shall try and answer it in simple fashion.
In todays time and age, movements in currency exchange rates signify movement of money from one geographical location to another as far as holding that currency is concerned. As far as the stock markets are concerned, it would be the FIIs (or foreign institutional investors) who would need to buy and sell various currencies to be able to buy or sell stocks at and through the local stock exchanges. For instance, if an FII decides that it wants to take a position in the Indian Stock Market, then it would exchange its US Dollars for Indian Rupees to be able to do so; this would cause an increase of the Rupee rate and a countervailing reduction in the Dollar rate in that regard. Now, if this FII were to decide to move from India to the USA as far as its stock holding is concerned; then it would be selling the Rupee to buy the Dollar, which would have the effect of reducing the Rupee and increasing the value of the Dollar. Currency rate fluctuations may be considered by some to be a lead indicator of what the big investors may be planning to do as far as their stock market investments are concerned.
Unemployment and interest rates similarly would have a direct bearing on the performance of the stock market. If both the unemployment rate and interest rate were to be high, then it would be a bearish scenario which would be facing the stock market of the geographical location under study; and vice versa.
It may be prudent to also keep the events occuring in the commodities exchange in perspective; which may also have a similar effect on the stock market you may have under study.
Sincerely,
Akash Akash
December 18th, 2009 at 6:47 pm
Currency Exchange:
Most people here will tell you the same thing, a rising currency (all else being equal) signals more investment into a country (i.e. more demand for the currency) and therefore a rising stock market. This is common knowledge, and it does not tell you how a weak/strong currency impacts the stock market, only how they can correlate. I will use a study by ABN Amro Bank and the London Business School to show strong currencies apparently don’t favour great stock returns. Their research showed countries with a weak currency saw greater stock returns than ones with a strengthening currency. This might seem strange at first, but when you think of it in terms of “real returns”, it will begin to make sense. If your currency is depreciating at a 5% annual rate against other currencies then your stock market has to increase more than 5% just for the value of the companies to remain the same.
Which is better:
1) a currency that depreciated by 10% and a market that rises by 6.5% = net -3.5%
Or
2) A strong currency that rises by 10% and a stock market that appreciates by 4.5%? = net +14.5%
Unemployment:
Conventional wisdom holds that stock prices are leading indicators of economic health, while unemployment figures are lagging indicators. This makes sense, because stock prices reflect real-time valuations of company health, whereas employers don’t make the decision to downsize (or restaff) until they feel like they’ve got a sense of long-term recession or growth.
Unemployment also makes an economy see less desirable, which can in turn lead to less foreign investment, therefore a sluggish stock market. This particularly the case if the world economy is growing while your country faces high unemployment.
Interest Rates:
An increase in interest rates will not directly impact the stock market. The direct effect is that it becomes more expensive for banks to borrow money from the central bank. They will pass on this cost to consumers, making credit more expensive, and therefore consumers will spend less, meaning lower profits for businesses. Also, businesses will find it difficult to obtain credit from the bank to expand, further pressuring growth. This will have a negative impact on the economy in the long run, but is immediately priced in by the stock market.
Furthermore, investing in stocks can be viewed as too risky compared to other investments. When the Fed raises the federal funds rate, newly offered government securities, such Treasury bills and bonds, are often viewed as the safest investments and will usually experience a corresponding increase in interest rates. In other words, the “risk-free” rate of return goes up, making these investments more desirable. Desired stock returns are usually priced by summing the risk-free rate and the risk premium, which will make investors seek a higher return, which might be found in other countries, typically emerging economies.
I’ve crammed lots for you as it came to me, hope it helps!
Also, Digger’s response is spot on. The stock market represents a subjective and collective view of the future. Matt