What you need to know about exchange rate forecasts
There is no reliable method available to forecast exchange
rates. Paul Krugman and Maurice Obstfeld write in their book "International
Economics: Theory and Policy" (New York, HarperCollins:1994):
If exchange rates are asset prices that respond immediately to
changes in expectations and interest rates, they should have properties
similar to those of other asset prices, for example, stock prices. Like
stock prices, exchange rates should respond strongly to "news," that is,
unexpected economic and political events; and, like stock prices, they
therefore should be very hard to forecast. In a study by Richard M.
Levich ("Evaluating the Performance of the Forecasters", in: Donald
R. Lessard, ed., "International Financial Management", New York: John
Wiley:1985, pp. 218-233) in which he surveyed the track record of
a dozen exchange rate forecasting companies through 1982 he found
little evidence that professional forecaster do systematically better
than an individual who, for example, uses the three month forward rate.
That does not imply that forward rates are good predictors. In fact,
they usually do not predict exchange rate movements very well.
How are exchange rates determined?
Long term movements are driven by fundamental forces, such
as purchasing power parity. In the short run,
exchange rate movements are driven by news and events.
For excellent surveys of exchange rate theory see:
• Richard Baillie and Patrick C. McMahon:
The foreign exchange market: theory and econometric evidence.
Cambridge University Press, New York, 1989.
• Lawrence S. Copeland: Exchange Rates and International Finance.
Addison-Wesley, Reading/Mass., 1990.
• Christian Dunis and Michael Feeny (editors): Exchange Rate
Forecasting. Woodhead-Faulkner, New York, 1989.
• Peter Isard: Exchange Rate Economics. Cambridge University
Press, Cambridge, 1995.
• Ronald MacDonald and Mark P. Taylor: Exchange Rate Economics:
A Survey. IMF Staff Papers, 39(1), 1-57.
If exchange rate forecasts are not reliable, why bother?
As pointed out above, economists do not possess reliable methods
of forecasting exchange rates over short time horizons such as
days or weeks. Fundamental economic forces (such as purchasing
power parity and balance-of-payment disequilibrium) usually take
much longer, often several years, to have an effect on exchange
rates. Nevertheless, the business community has to form
expectations about the short-term trends of exchange rates. Because
these expectations are formed by market sentiment, trends can be
extrapolated. At the same time, market sentiments can change as
financial news can change the outlook on a country's economic
prospects. The PACIFIC Exchange Rate Service provides three sets of
exchange rates trends using two different "technical" trending
techniques for 15-day and 30-day intervals, and ARIMA regression
forecasts for a 4-week interval.
Trends based on economic fundamentals (usually for quarterly
or annual projections) are usually obtained through large structural
The PACIFIC trends are intended to reveal market trends, not
fundamental determinants. Users of the trend charts are advised
to read them with considerable caution.
How the trends were calculated
The 120-day corridor analysis and 30-day trend projection
is based on technical analysis of the linear trend and
a surrounding band that maximizes a score function to make
the corridor narrow but long. The corresponding channel
analysis and 15-day trend projection uses multiple
channel segments that are at least 15 days long
and minimize an objective function that penalizes breaks.
Note that with any technical analysis, different parameter
assumptions yield different outcomes.
An inherent limitation of this approach
is that trend projections cannot predict trend reversals.
The 4-week forecasts employ auto-regressive integrated moving-average
ARIMA(p,q,r) regressions with degrees (p,q,r) chosen automatically
by the R forecast package, based on the logarithmic exchange rates of
the last 120 days. The expanding ribbon shows the
80-percent confidence interval of the ARIMA forecast.
The slight choppiness of the ribbon is an artifact of the
forecasting method for workdays (Monday through Friday)
while excluding Saturdays and Sundays. This feature is intentional.
All trend projections were coded in the R language by the author.
The current versions of the software were developed in January 2023.
I make no warranties, express or implied, that the exchange rate
trends/forecasts are accurate, useful, consistent with any economic
theory, reliable, or consistent with any particular standard of
merchantability, or that they will meet your requirements for any
particular application. These forecasts should not be relied upon for
carrying out any currency transactions which could result in injury to
a person or loss of property. If you do use the forecasts in such a
manner, it is at your own risk. I disclaim all liability for direct
or consequential damages resulting from your use of these forecasts.