Forecasting Exchange Rates

An analyst can apply the Absolute PPP theory (Purchasing Power Parity) of exchange rates to measure a currency’s fundamental value, by comparing the real cost of like goods across different countries.

An analyst can apply the Relative PPP theory of exchange rates to forecast currency values, if the analyst has strong insights into inflation expectations for these countries over the period of time in question.

An analyst can look at a country’s balance of payments to make inferences about the future strengthening or weakening of a currency.  Theoretically, when the official reserve account shows a negative balance, the country is likely acquiring foreign assets and the currency should be strong.

An analyst can also track a country’s monetary policy to make short and long term inferences about interest rates and inflation.  This is called the asset markets approach.

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