Forex forecasts

Forex forecasting is the blood stream of forex trading.

This is like the holy grail. Technically speaking, forecasting is a part of statistical analysis. The way statistician do forecasting is that they create confidence intervals at a given horizon like 6 months. But the width is always too much for their forecast to be of any use in applied finance.

Former FED Chairman Alan Greenspan himself said that making currency predictions was like flipping a coin. Back to the statisticians, his comments were perfectly accurate as this is corroborated by the random walk theory.

On the other hand, economists love to make predictions or “forex forecasts“. Interestingly economists may reach the same conclusion with respect to the direction of a currency, even if they use opposite assumptions.

For example after a recession, investors who are bullish on the American economy may forecast the US dollar to strengthen versus other currencies as the USA leads the recovery. Conversely investors who believe that the recession will continue in the medium term may forecast that the US dollar will be strong as a haven from world markets turmoil.

Bloomberg is a sophisticated financial software platform including forex forecasts. Typing the function “FXFC” on one of their terminals will bring the analysts predictions for any major currency pair such as the euro versus US dollar. You can also use the function “FXIP USD” to get the most recent headlines and economic news about the US dollar. FXFC will bring up all forex forecasts by the major bank analysts.

Another argument brought by yet a third type of economists goes as follows. If a serious recovery is under way, then investors will pull their money out of US dollars to buy higher-yielding assets such as emerging market bonds. Leading to USD weakness. This would occur if the overall perception of risk in the market place were decreasing, and this is something that can be confirmed by observing implied volatility.

Implied volatility always rises in panics and recessions, reaching a climax at the bottom of the market, then progressively receding to quieter levels. This is a key parameter to watch in order to make forex forecasts. When volatility decreases in the foreign markets, investors who fled months earlier come back with a renewed risk appetite.

A fourth argument in the realm of forex forecasts is that in the middle or end of a recession, the US trade deficit normally shrinks. This leads to less trade related demand for foreign currencies and hence this is another reason for the dollar to strengthen.

Trade deficits will certainly play a major role in the direction of the U.S. dollar in the future. China the biggest importer to the US is also the largest holder of U.S. Treasury Bonds. China and the United States must work together and letting the green back move too far in either direction will definitively hurt both countries.