3 Pillars to FX
Rate differentials, growth differentials, risk sentiment — the synthesis
- Name the three pillars driving FX and weight them correctly
- Diagnose which pillar dominates in a given regime
- Build a top-down FX view from the three inputs
Every FX move can be traced to one of three things: rate differentials, growth differentials, or risk sentiment. Most traders watch one. The best watch all three and weight them according to the regime. This is the synthesis briefing.
Pillar 1: Rate differentials
The gap in yields between two currencies. US 2y minus Bund 2y for EUR/USD. US 10y minus JGB 10y (historically) for USD/JPY. Wider gap in favour of currency A → A strengthens. This pillar dominates in 'normal' regimes (no crisis, no extreme growth divergence).
Pillar 2: Growth differentials
Which economy is growing faster. Strong GDP, hot PMI, positive surprise index in one country → that currency benefits. Dominates when rate differentials are similar but growth diverges (Fed-vs-ECB 2014-15 was both rate AND growth).
Pillar 3: Risk sentiment
The global mood. Risk-on → high-beta wins (AUD, NZD, EM). Risk-off → safe havens win (USD, JPY, CHF). Dominates in crises, vol spikes, geopolitical shocks. Can override rate + growth pillars temporarily.
All three point the same way → high-conviction directional trade. Example: US rate differential widening + US growth surprising + risk-on (USD bid as carry funding). Strong USD trend.
Rate says one thing, growth says another, risk sentiment a third. Choppy market. Best to sit out or size down — pick the pair where TWO of three pillars align.
The synthesis question
For any pair, ask: 'What's the rate-differential trend? Growth-differential trend? Current risk regime?' Count how many of the three favour your direction. Three of three = high conviction. Two of three = moderate. One of three or fewer = avoid or fade.
EUR/USD: Fed cutting faster than ECB (rate differential favours EUR), US growth still outperforming (growth differential favours USD), risk-on regime (neutral). Best action?
- Three pillars: rates, growth, risk sentiment
- Each can dominate depending on regime
- All three aligned = highest conviction
- Trade pairs where pillars agree; skip pairs where they conflict
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