The dollar was erratic in the 1990s. It was relative strong in the 1997-1998 period, as funds flowed into the U.S. during the Asian crisis. It weakened against some currencies in 1999, perhaps because of its relatively low interest rate. Explain why a public forecast by a respected economist about future interest rates could affect the value of the dollar today. Interest rate movements affect exchange rates.
Speculators can use anticipated interest rate movements to forecast exchange rate movements.
They may decide to purchase securities in particular countries because of their expectations about currency movements, since their yield will be affected by changes in a currency's value. These purchases of securities require an exchange of currencies, which can immediately affect the equilibrium value of exchange rates If a forecast of interest rates by a respected economist was already anticipated by market participants or is not different from investors original expectations, an announced forecast does not provide new information. Thus, there would be no reaction by investors to such an announcement, and exchange rates would not be affected. Assume that substantial capital flows occur between the United States, County A, and Country B. in all directions. If interest rates in Country A declined, then Country A investors may attempt to capitalize on higher U.S. interest rates, while U.S. investors do not invest in Country A's securities.