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Currency markets explained: how central bank policy, interest rate differentials and economic data drive EUR/USD, GBP/USD and the other major pairs.
18 articles
A bilateral rate tells you what a currency did against one other. REER tells you what it did against everything a country trades with, adjusted for inflation - which is what competitiveness actually depends on.
Buy a foreign asset and you have bought two things - the asset and the currency. Hedging separates them. Most people never consciously decide, which means they decided by default.
The same event that moves the euro by a fraction of a percent can move an emerging market currency by several. The reasons are structural - and they compound each other.
In a crisis, capital moves toward a small set of currencies. The reasons are structural rather than sentimental, and one of them is genuinely counter-intuitive.
The currency market runs continuously for five days a week, but it is not the same market throughout. Liquidity, spreads and typical behaviour change with the trading session.
The dollar is not just one currency among many. It is the unit most trade is invoiced in and most cross-border debt is borrowed in, which is why its level reaches markets that have nothing to do with the United States.
Some brokers pass your order to the market. Others take the other side of it themselves. Knowing which one you are using tells you where their interests align with yours and where they do not.
PPP says identical goods should cost the same everywhere once converted. Reality disagrees for decades at a time, and the reasons why explain a great deal about currencies.
A peg is a promise to defend a price with finite reserves against an opponent with no such limit. Here is the mechanism, the trilemma underneath it, and the pattern every collapse follows.
Borrow where rates are low, lend where they are high, pocket the difference. The carry trade is simple to describe, profitable for long stretches, and prone to violent unwinds.
The DXY is the headline measure of dollar strength, but its weightings were set in 1973 and it is more than half a euro trade. Here is what it measures and when to use something else.
Verbal warnings, direct intervention, capital controls and coordinated action. Central banks have several tools for influencing a currency, and their track records differ sharply.
The Fed rarely surprises with the rate itself. What moves currencies is the projected path, the language, and the gap between what the market expected and what it heard.
Forecasting a currency pair with a single number is close to useless. Building a scenario map — what happens under each policy path, and what would falsify it — is a far more honest method.
EUR/USD is roughly a quarter of all foreign exchange turnover. Its movement comes down to the rate differential, growth divergence, energy, and the dollar's role as a safe haven.
A pip is the unit currencies move in. A lot is how much you hold. Combining them gives the number that matters most — what one pip of movement costs you in real money.
Leverage does not make you more likely to be right. It shortens the distance between being wrong and being closed out. Here is exactly how margin, liquidation and position sizing interact.
Sterling against the dollar is more volatile than EUR/USD, and for identifiable reasons: a smaller economy, a large current account deficit, and an unusually finance-heavy composition.
