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Originally Posted by Freefox
Thanks for that John.
I understand what you mean about the competing fundamentals and the need to somehow quantify the influence each factor will have on the currency pair to determine future projections. I imagine this is where fundamental analysis gets very complicated and hence why there can be differing views as to just what the impact a particular element has.
You mention everything else being equal that a 1% cut by the RBA would lead to the Aussie dollar depreciating against the Franc. I can see that on a carry-trade, with a 100,000 CHF position this would lead to a loss in the interest amount acrued of 1,000 CHF over the course of the year if it was held as Australian dollars. Is my thinking and logic correct here? I know on its own this would be a silly thing to do as it doesn't take into account any capital depreciation, but I'm highlighting it purely as an exercise to understand the mechanics of the carry-trade.
On a further point if my math is correct above, is there a calculation/model that can be applied thats says that for a 1% interest rate cut in one currency (AUD), it can forecast what the exchange deprecation against another currency (CHF) would be? You mentioned about deteriming the influence of each factor and was wondering if that such a model existed to quantify interest rate movements between currencies or are things not as simple as that?
Thanks once again. I do appreciate your time reporting on this thread.
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Perhaps if you were working with neural networks or something else that can process many different variable at once, you could perhaps get a good forecast for price action (if we could, it would certainly be exploited by banks and traders to the point that it wouldn't work anymore).
The problem here is that the response in price isn't necessarily to the rate hikes or cuts, but speculation of rate hikes and cuts over time.
You also have to consider that these are benchmark lending rates we are talking about. Banks aren't even able to access these optimal lending rates (except for those large lenders that deal with the central banks). Big banks lend to each other at the overnight Libor rate. Regular retail traders have access to a rate that is well above the Libor rate as their credit worthiness is much lower. So you end up getting a much lower rate than 7.00 percent holding the Aussie and have to pay much worse than 2.75 percent for borrowing francs.
Then, there is still the issue that there are other market dynamics to take into account for fundamental price action.
So, while we could theoretically measure the impact this shift in rates could have on price action in a vacuum; in the real world its impossible. Therefore, its best just to approximate. Of course, since price adjusts on rate expectations rather than the actual hike or cut itself (unless there is a surprise), it requires you to be on top of things and take some discretion of your own - (are these expectations reasonable and while they grow more or less aggressive with time?).
