Predicting Currencies
By Twickenham Advisors on August 11, 2017
“[D]espite extensive efforts on the part of analysts, to my knowledge, no model projecting directional movements in exchange rates is significantly superior to tossing a coin. I am aware that, of the thousands who try, some are quite successful. So are winners of coin-tossing contests. The seeming ability of a number of banking organizations to make consistent profits from foreign exchange trading likely derives not from their insight into exchange rate determination but from the revenues they derive from making markets” – Alan Greenspan
Remember about five years ago, when some of your amigos were telling you that they had other friends who were buying Iraqi dinars? Well, hopefully, you didn’t bite because that was a scam: Iraqi Dinar Scam. A general consensus that many people believe is that no model has consistently predicted currency moves with any statistical significance. Yet, programmers and hacks still try to build computer models to make fortunes in the currency markets. I agree with Alan Greenspan on this subject: predicting currency moves is largely a coin toss.
Study after study indicates this perspective. As Ken Rogoff said, “[w]e find that a random walk model performs as well as any estimated model […]”. In fact, currencies often move counter intuitively. Example one of one zillion happened just last year. In December 2015, the Fed hiked interest rates…something no central bank had done in a while. Then, a few months later, the Bank of Japan, the People’s Bank of China and the European Central Bank all lowered rates (to negative rates in Europe and Japan) and stepped up asset purchasing (QE). And yet the euro and yen both appreciated against the dollar. Insane, right? Welcome to forecasting currency rates. You drinking my sake, kemosabe?
This isn’t to say that there isn’t any diversification benefit to holding international equity positions in a foreign currency, or that banking organizations can’t make profits with carry trades (selling low yielding currencies to buy higher yielding ones). I just wouldn’t trust a money manager telling you he has a system to consistently profit on currency trades. Also, don’t switch all of your international equity funds out for US Dollar (USD) hedged funds after the dollar appreciates. As soon as you do, the dollar will turn the other way, and your old funds will be the next category killers. And believe me, there are both institutional and garage-hedge fund guys coming out every year with a new system, promising El Dorado. When the currency trading sirens sing, take Circe’s advice: “[P]lug your comrades’ ears with softened beeswax lest they listen, and row swiftly past […]”