Ask the Institute

DATE: December 09, 2013

QUESTION:

What is the relationship between foreign currencies, the stock market and interest rates?

ANSWER:
Many traders attempt to make a connection between currency values and the rise and fall of the stock markets. While a change in foreign exchange rates could coincide with the change in the value of the market, the relationship is likely to be rooted elsewhere, namely in the world of interest rates.

To use money market accounts as an example, suppose some event whether inside or outside of the U.S., causes interest rates to change within the U.S. If interest rates decline, money market accounts will pay less interest, making money market accounts less attractive and borrowing money to buy stocks become more attractive. If interest rates rise, then the money market account could pay more interest. As a result, money market accounts become more attractive and borrowing money to buy stocks will become less attractive.

Also, when interest rates rise in the U.S., relative to other countries, foreign currencies could be converted into U.S. dollars. Why? Because investors may want the higher rate of interest offered here. To learn more about the relationship between foreign currencies, the stock market and interest rates, view this segment of "Ask the Institute."