Strategists expressed concern at the Morningstar investment conference over the inversion of short term vs long term interest rates in the Indian and Brazilian interest rate market; and for good reason, studies show the yield curve to be a leading indicator of GDP slowdowns.
This could also be a negative for the Indian Rupee and Brazilian Real for the next 12 months if a recent study is any guide.
In a no-arbitrage framework, any variable that affects the pricing of the domestic yield curve has the potential to predict foreign exchange risk premiums. The most widely used interest rate predictor is the difference in short rates across countries, known as carry, but the short rate is only one of many factors affecting domestic yield curves. We ﬁnd that in addition to interest rate levels other yield curve predictors have signiﬁcant ability to forecast the cross section of currency returns. In particular, changes of interest rates and term spreads signiﬁcantly predict excess foreign exchange returns, exhibit low skewness risk, and are lowly correlated with carry returns. Predictability from these yield curve variables persists up to 12 months and is robust to controlling for other predictors of currency returns.
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