The Art and Science of
Currency Research


Mike Keenan

Head of Fixed Income and Currency Research


Accurate foreign exchange (FX) research is a vital business tool in volatile markets and uncertain times. How do currency researchers provide the insights that help clients plan ahead?

In February 2018 the rand was trading at about R11,50 to the US dollar. Barely two years later, it hit R19 before dropping down to its current levels of around R14. Where will it be in a year or two – or even six months – from now? While it’s impossible to know the exact future value of the currency, Absa CIB’s Currency Research team has a few ideas.

The bank’s researchers have come under the spotlight during the unprecedented market volatility brought on by the COVID-19 pandemic.

“There’s no doubt that a lot of the models we use to quantify our views into forecast numbers have been tested,” says Mike Keenan, Head of Fixed Income and Currency Research at Absa CIB. “But while some of our quantitative thinking has been tested, it also provides a lot more rigour to our analysis. The volatile market forces us to adapt to very dynamic environments, such that we haven’t seen for around a century. It has also caused us to think about alternative approaches, especially in the currency world. The world has changed, and we’ve introduced new models and applied different schools of thought to determine a fair value for the currency.”

Keenan adds that while the disruptive events of recent months have made currency research more difficult, they have also emphasised the need for having access to reliable, quantifiable research in the first place.

Scenario-based analysis

Absa CIB’s research provides a pan-African view, with detailed analysis of the South African and African macroeconomic background. This includes market analysis of key macro variables such as GDP, inflation and balance of payments, as well as exchange rate movements and bond market developments.

Keenan says that the research approach has evolved to provide scenario-based analysis, both in South Africa and the rest of the continent. “This allows us to give clients a baseline view, as well as some plausible high- and low-road possibilities,” he explains. “For example, we might think that the rand will be at X at the end of the year, but we’re also mindful that it could be at Y. And we communicate those views. They have to be plausible views, because it's no good saying the rand is likely to be ‘somewhere between R10 and R20 to the US dollar’.”

This depth of advice enables clients to plan appropriately, and to avoid falling into the trap of basing their financial planning on a particular point forecast.

To lend even more depth and accuracy to Absa CIB’s research, the team consults with specialist experts. “For example, when South Africa had a Cabinet reshuffle we brought in external political analysts and role players in that dynamically changing environment,” Keenan says. “We’re sticking to what we’re good at, and we’re helping our clients by giving them the ability to tap into the experts in whichever topical area is driving the markets at any given time.”

Model, quantify and measure

Absa CIB’s researchers draw their analyses from a wealth of data: charts, graphs, tables and trends. But is their work entirely science, or is there an element of art to it as well?

“It’s a combination,” says Keenan. “The art lies in determining the key drivers and the appropriate school of thought. When we think about the currency markets or the bond market, we have to assess the following: What are people thinking about? What is driving the markets? We use certain statistical models to get a sense of that, but that is where the subjectivity comes in. Once we have decided on that, we then apply rigorous analysis to test it.”

While the average armchair analyst might get away with some of that, it takes experience and expertise to create a full forecast and accurate analysis. “It’s one thing for guys to stand around a braai and say, ‘Hey, I think the rand is going to R20 because I heard this or that story,’” says Keenan. “It’s another thing to say, ‘There are specific challenges to South Africa’s GDP and to the national fiscus, so let’s work out what the fair value of the currency is based on GDP differentials and our fiscal differentials.’

“Now there might be merit in what the guy standing around the braai is saying,” Keenan concludes, “but as researchers we have to take that theory and test it. We model, we quantify and we measure. That’s where the art and the science combine.”

Mike Keenan

Head of Fixed Income and Currency Research

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