Fundamental Analysis Key to Understanding Long-Term Currency Movements

The foreign exchange market has returned to the spotlight after major currency movements displayed sharp dynamics in recent weeks. Amidst global uncertainty, exchange rate fluctuations increasingly confirm that short-term emotions and market momentum often dominate directional moves. “In the short run, the market is a voting machine, where momentum and irrational emotion reign. But in the long run, the market is a weighing machine, striving for a perfect equilibrium between supply and demand, between greed and fear,” said Elev8 Markets Analyst, Kar Yong Ang, in a press release on Monday (6/7/2026). This statement underscores that fundamental analysis is more relevant for understanding long-term directional trends, even though daily traders are more frequently influenced by sentiment and momentum. One classic approach to assessing exchange rates is purchasing power parity (PPP). This theory posits that the price of an identical basket of goods should be the same across different countries, with the exchange rate acting as the balancing mechanism. Kar Yong Ang added that PPP provides a starting point for understanding whether a currency is cheap or expensive, although in practice, many assumptions make the theory less directly useful. A popular example is the Big Mac Index, which is used to assess whether a currency is overvalued or undervalued. Beyond PPP, the Bank for International Settlements (BIS) introduced the Exchange Rate Effective Index, which measures a currency’s value against major trading partners. Its real version, the Real Effective Exchange Rate (REER), also accounts for inflation, thus better reflecting competitiveness. “An increase in the REER often signals a strengthening of the currency in real terms, although it is not an immediate turning point signal for traders,” Ang explained. Meanwhile, the International Monetary Fund (IMF) also routinely assesses global exchange rates, though the results are more relevant for long-term horizons compared to daily trading decisions. However, in trading practice, the fundamental factor that most often bridges theory and reality is monetary policy. Interest rates are the primary instrument, although over the past decade many central banks have employed quantitative easing policies. “The most useful way to understand interest rates is to compare them across different countries. Bond yield spreads often provide clues about the direction of currency pair movements,” Ang said. For instance, the interest rate differential between the United States (US) and Australia can influence the AUD/USD currency pair. A widening spread typically encourages a strengthening of the Australian dollar, and vice versa. Thus, while long-term valuations such as PPP or REER provide a conceptual framework, traders still need to focus on interest rate dynamics and market momentum. Fundamental analysis is not merely theory, but a tool for understanding the context behind daily price movements.