Where Are Foreign Exchange Rates Headed?

By Bound

18/07/2024

When considering exchange rates without any changes in economic factors, a common misconception is to assume that the exchange rate will remain unchanged. However, even in the absence of volatility, exchange rates tend to change slightly due to differences in interest rates between currencies.

This subtle change is captured by the forward curve, which projects the expected exchange rate based on current exchange rates and interest rate differentials. The forward curve provides a more accurate forecast of future exchange rates, reflecting the impact of interest rate disparities.

Ignoring the forward curve is similar to assuming that any volatility in exchange rates will perfectly offset the effects of interest rate differences, which is an unrealistic expectation.

A more practical approach is to anticipate that exchange rate volatility will occur around the forward curve, rather than along a flat line. This perspective acknowledges the inherent influence of interest rates on exchange rates, even when economic factors remain constant.

Watch the full video by Bound to gain a deeper understanding of how interest rates influence exchange rates and the importance of considering the forward curve in your financial analysis.

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