Macroeconomic Fundamentals' Predictability of Currency Returns

Abstract

We study the relationship between macroeconomic fundamentals and currency returns from the perspective of a British investor. To investigate the relationship more closely, we replicate the methodologies presented by Dahlquist and Hasseltoft (2020) and implement it using the British pound as domestic currency. Based on our analysis we find an “economic momentum strategy” that exhibits a Sharpe ratio of 0.24 and that is outperformed by the carry trade strategy. Furthermore, we conclude that macro fundamentals linked to economic activity and inflation do not significantly predict currency returns from this perspective.