Forex: Spare Capacity

Buy when the coloured lines are at the low end of their range, sell when they are high

This tool looks at the historical relationship and likely future development of a variable closely correlated with exchange rate movements - namely differences in the pressure of demand between economies, as expressed in the amount of spare capacity. The historic data is a set of annual estimates calculated by PIT for all countries in the database. This ratio is similar to IMF and OECD definitions for GDP Output Gaps. For comparability, exchange rates have been rebased to set year-end 1994 at 100.

In each chart the foreign currency index is shown as the thick white line on the right hand axis. The main explanatory variable, domestic less foreign spare capacity, uses the left hand axis, shown as the thin yellow line. A Best Guess as to the future development of the variable is also shown on the left hand axis, as the thin orange line.

Best Guesses show what would happen to the difference in the pressure of demand based on forecasts for spare capacity, both at home and abroad. Depending on whether the investment perspective is Dollar-based or relative to a global benchmark, the relevant foreign forecasts are those for the United States or a GDP weighted global average. PIT forecasts of each GDP output gap are in turn based on consensus estimates for GDP.

Owing to the conversion of legacy currencies into Euros, analysis is provided on the common currency, rather than for individual countries. Historical data is provided by creating synthetic GDP-weighted time-series for the component currencies, expressed in the European Currency Unit.

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