The impossibility of currency forecasting and why we try anyway
By Lars Christensen, Founder & CEO, mamoadvisory.com, +45 52502506
It is probably 20 years since I made my first currency forecast, and I continue to make currency forecasts to this day. However, I have never made it a secret that I don’t think you can systematically beat the market – and particularly not the currency markets.
I tend to think that currency markets are what economists call ‘efficient’. All available public information is reflected in market pricing, which makes it impossible for anybody to systematically outperform unless they have insider information.
Furthermore, ever since I started forecasting currencies, the empirical literature has demonstrated over and over that exchange rates – particularly in the short run – follow what economists call a ‘random walk’. Guessing whether a currency goes up or down (relative to market expectations) is like flipping a coin. This is precisely because currency markets generally already reflect all publicly available information.
Given my reservations about the chances of beating the market, one could obviously ask why am I doing it? The simple answer is: I am getting paid for doing it. The more correct answer is that I have to do it – in the sense that living is about making choices. Everything we do to some extent is about forecasting. When we cross the road, we are making an estimation about whether or not a car will hit us. We evaluate risk.
Any company with expenditures and income in different currencies must have a view on what will happen with exchange rates. They will have to decide whether or not to hedge currency risks in the exact same way they decide on having fire insurance.
Avoid getting beaten
My views on the currency markets have developed a lot since the late 1990s, even though my view is exactly the same now as it was then. Twenty years ago – as today – I believed that you couldn’t systematically beat the currency market. However, today my focus has changed from thinking about beating the market to trying not to be beaten by the market. This is something I believe can be done.
Generally, I think my currency forecasts are as good as market forecasts – by which I mean what the so-called forward markets are telling us about future exchange rates. I have come to the firm conclusion that this kind of accuracy can be achieved by a systematic focus on the four or five factors that the economics textbooks say drive exchange rates – relative inflation and relative monetary policy, productivity, terms of trade, and external imbalances.
If your attention doesn’t waver from these indicators, then you have a pretty good chance of matching the market and even beating it from time to time. Most of all, I think there is a lot to gain from ignoring ‘political noise’, which is often just that when it comes to currency forecasting.
Do you want FX forecasts?
Money and Markets Advisory does not publish exchange rate forecasts, even though we produce them for our own internal consumption, so to speak. However, some clients have expressed interest in getting exchange rate forecasts from us.
The question is – would you pay for a service that provides exchange rate forecasts? Let us know about your thoughts and needs, including the currencies and time horizons that interest you.