One-week results

All trading systems can be classified as either trending or mean-reverting in nature. Suffice to say most currency traders treat their markets as trending, and with good reason. The expected movements in relative short-term interest rates, relative returns on assets, and macroeconomic trends all tend to be persistent.

Let’s see if this is true for currencies one week after a short-term interest rate shock. For large down moves in the ED3 price — that is, large upward interest-rate moves — the means of currency returns are significantly different one week later.

This relationship is not symmetric, however. One week after a large downward movement in the ED3 price, there are 85.2-percent and 50.7- percent probabilities the DEM/EUR and GBP means, respectively, have converged back to those of the population as a whole. The variances are the same.

This is a way of saying the currency market understands that down moves in U.S. short-term interest rates are going to be limited. There is good resistance at zero percent, and it takes exponentially more effort for short term rates to achieve each additional basis point lower in yield.