What if you knew next year’s inflation, interest rates and economic growth across all G10 currency areas in advance? Surely you could predict which currencies would strengthen and which would weaken.
Surprisingly, probably not.
In their famous 1983 study, Richard Meese and Kenneth Rogoff tested several leading exchange-rate models against a driftless random walk: a model in which exchange-rate changes are unpredictable and the best forecast of a future exchange rate is therefore simply today’s rate.
They tested major dollar exchange rates over horizons from one to twelve months. And they gave the economic models an extraordinary advantage: the forecasts were based on the actual future values of the explanatory variables — information a real-world forecaster could never possess in advance.
Yet the sophisticated models failed to beat the random walk — and often performed worse.
Four decades of research have made the picture more nuanced, but not necessarily more comfortable. Exchange rates are not completely disconnected from fundamentals. Over longer periods, relative prices, monetary policy, valuation and external positions can exert influence. But their forecasting power remains unstable.
Barbara Rossi’s 2013 review of the exchange-rate forecasting literature reached a rather unsatisfying conclusion: whether exchange rates are predictable “depends”: on which currency you look at, over what horizon, in which market regime and with which model.
And the shorter the horizon, the more complicated the picture becomes.
Over days or weeks, markets react not simply to inflation, growth or interest rates, but to how those outcomes compare with what was already priced in. A hawkish central bank may fail to strengthen its currency if the market as a whole had already priced in an even more hawkish outcome. A modest surprise can create, at least in the very short term, a large move as the market rapidly reprices the new information — through fresh speculative positions, the unwinding of crowded trades, hedging flows or portfolio rebalancing.
That is why we do not rely on macro forecasts.
Instead, we attempt to identify profitable trades through technical analysis: studying what the market itself is revealing through price action, momentum, volatility and changing behaviour.
But that does not make success guaranteed. Far from it.
If technical analysis were simply a matter of finding a few reliable patterns and repeating them forever, everyone could do it. Markets adapt. Signals decay. Strategies that worked beautifully can stop working.
Success therefore requires more than discovering a profitable pattern once. It requires falling down, getting back up, testing again, accumulating experience — and, perhaps most importantly, never falling in love with yesterday’s success.
Perhaps overcoming that challenge is the real skill in currency trading. Not predicting the economy.
