Foreign Exchange and the Dollar

A currency pair names a base and a quote currency. EUR/USD at 1.09 means one euro buys 1.09 dollars. When the number rises, the base has strengthened against the quote.

This is not pedantry. A headline saying the euro strengthened, on a day when the dollar weakened against everything, has attributed a move to the wrong side of the ratio and will produce the wrong conclusion about what caused it.

• Interest rate differentials: capital moves toward the currency offering more, all else equal.
• Growth expectations: relative economic strength attracts investment flows.
• Inflation: persistently higher inflation erodes a currency's purchasing power.
• Safe-haven demand: in stress, flows historically move toward the dollar, the yen and the franc.
• Trade and current account balances, which set a slower background drift.
• Central bank intervention, which is rare, announced or inferred, and can be violent.

Rate differentials dominate over horizons of months. The mechanism is straightforward: money held in a currency earns that currency's short rate, so a widening gap between two policy rates is a widening gap in what holding each one pays.

A US company selling in Europe collects euros and reports in dollars. If the dollar strengthens ten percent, those unchanged euro sales convert into fewer dollars, and reported revenueRevenueWhat a company billed customers over the period, before any cost is subtracted.Read the full explanation falls without a single unit of volume being lost.

This is why filings and earnings calls routinely quote growth on a constant-currency basis, restating the period as if exchange rates had not moved. It is a legitimate disclosure that isolates the underlying trend, and it is also a place to read carefully, because the cash a company actually banks is the reported figure and not the constant-currency one.

The size of the effect depends on how much of a company's revenue is earned abroad, which is disclosed in the segment reportingSegment reportingThe required breakdown of results by business line or geography inside a filing.Read the full explanation note. A domestic retailer is unaffected; a large-cap technology company earning half its revenue overseas is affected substantially.

Most globally traded commodities are priced in dollars, so a stronger dollar makes them more expensive in every other currency and tends to weigh on demand. The historical inverse relationship between the dollar index and commodity prices comes largely from this arithmetic rather than from anything more exotic.

The relationship is a tendency and not a law. A supply shock can lift oil while the dollar is also rising, and both moves can be entirely coherent, because they are being driven by different things at the same time.

A currency price is always a ratio of two currencies, so every quote has a base and a quote currency, and the convention determines which is which. EURUSD at 1.09 means one euro buys 1.09 dollars: the euro is the base and the dollar is what it is priced in.

• The base currency is the first of the pair, and the number says how much of the second it buys.
• A rising number means the base strengthened against the quote currency, which is why EURUSD rising is dollar weakness.
• Some pairs are conventionally quoted the other way round, USDJPY among them, where a rising number is dollar strength.
• A pip is conventionally the fourth decimal place for most pairs and the second for yen pairs.

The second and third points together are the source of most confusion in reading currency commentary. Whether a rising chart means the dollar strengthened depends entirely on which side of the pair it sits, and the convention is not consistent across pairs.