This week's purchasing managers' indices (PMIs) from Europe and the U.S. were generally better than expected. It looks like the developed world may be growing again despite the slowdown in China. That should be beneficial for growth of the world economy as a whole. So how might stronger growth affect currencies?
Contrary to popular belief, a strong economy does not necessarily mean a strong currency. A currency isn't the stock price of a country, which goes up when the country's "results" beat expectations. Currencies go up and down for a lot of reasons, some of which may be affected counter-intuitively by growth.
There are of course many ways in which a strong economy would naturally translate into a strong currency. An economy that's growing faster than its neighbors would tend to attract inflows of capital into its stock and bond markets, as well as direct investment. It might have higher interest rates than other countries that were struggling. Its economy could be doing well because of robust exports, which might mean a trade surplus. All of these factors would tend to support a currency.
On the other hand, sometimes an economy speeds up because of monetary stimulus, which means low interest rates and a weak currency. Some countries tend to import more when they are doing well and struggle with balance-of-payment problems. And risk-seeking sentiment tends to improve when a country's economy is doing well, leading to more willingness to invest abroad.
It seems reasonable that a weak economy would have a weak currency, but that could be putting the cart before the horse. Sometimes an economy might be weak because its currency is too strong. Examples of that might be if the country has found oil or is seeing a large inflow of funds into its bond markets to take advantage of high interest rates. On the other hand, sometimes an undervalued currency can offer the country a competitive advantage that helps its economy to growth faster.
(Read More: Watch Out, Euro May Be About to Flex Its Muscle)
Finally, a collapse in the economy can actually cause the currency to rise, as happened in some countries in Asia after the 1997 crash. Imports slowed dramatically as residents slashed their spending, but exports kept up as usual since those countries' trade partners were unaffected. The resulting trade surpluses caused the currencies to recover (or at least allowed the countries involved to rebuild their foreign exchange reserves).
You can see the relationship between growth and currencies from this graph, which shows the change in the DXY index of the dollar's value compared to the U.S. economy's growth rate relative to that of the other countries whose currencies comprise the index - which is 57.6 percent euro, 13.6 percent yen, 11.9 percent pound sterling, 9.1 percent Canadian dollar, 4.2 percent Swedish Krona and 3.6 percent Swiss Franc.