Question

Security prices are driven by a variety of factors, but corporate earnings are clearly one of the primary drivers. And corporate earnings, on average, follow business cycles. Exchange rates, as they taught in college, reflect the market’s assessment of the growth prospects for the economy behind the currency. So, if securities go up with the business cycle, and currencies go up with the business cycles, why do we see currencies and securities prices across the globe not going up and down together?

Answer 1

Exchange value change as a result of many factors and not solely because of business cycles. Expected changes in inflation, interest rate, political and country risk and account balances are all responsible for the movement of exchange rates.

Secondly, even if business cycles were a primary driver of currency values, business cycles are not perfectly correlated globally. A typical example is in 2001–2002, most of the major industrial economies were either in recession or near recession, but currencies still fluctuated widely.The Japanese yen first depreciated against the dollar in the early part of 2002, but still appreciated significantly by mid-year.