Speculators expect the dollar to fall

The chain in words

1. Step 1

   Before the rumor

   This is the market for US dollars, priced in euros per dollar. The horizontal axis is the quantity of dollars traded and the vertical axis is the exchange rate. The market is at E₀.

2. Step 2

   Demand for dollars shifts left

   Nobody wants to buy an asset they expect to fall. Foreign buyers hold off, so demand for dollars shifts left at every exchange rate.

3. Step 3

   Supply of dollars shifts right

   Holders of dollars sell before the drop, so the supply of dollars shifts right. Both shifts push the exchange rate down, and the dollar depreciates now, to E₂. The expected fall has caused itself.

Takeaway. Expected depreciation cuts demand and raises supply of a currency, so it depreciates immediately.

Draw it yourself

More on the foreign exchange market graph