Every currency has its personality and there are various groups in which currencies are classified. Because some currencies have similar personalities, they are also correlated. This grouping is important not only for analyzing currencies but also for hedging.
- The Majors: The Majors is a group of currency pairs which include EUR/USD, GBP/USD, USD/JPY, AUD/USD, USD/CAD, and USD/CHF. Each of these currency pairs possesses some degree of correlation with one another. For example, EUR is related to the CHF because of the economic connections between the two nation’s economies. As a currency pair group, they are more suitable for trading by novice traders than managed currencies.
- USD Smile: Compared to almost all other global currencies, the USD possesses some unusual characteristics. This is mainly because the US dollar accounts for most of the world’s reserve currency and dominates global trades. Morgan Stanley Strategist, Stephen Jen coined the term “dollar smile” in 2001. It theorizes that the US dollar appreciates when the economy is either doing exceptionally well or very poorly. It also suggests that the USD depreciates in value when the US economy is in between. For traders, they should buy the USD when the US economy is either booming or in a recession and should sell the USD in other scenarios.
The dollar smile model represents an accurate picture of the performance of the US dollar. It suggests that the USD rallies when the economy of the US is either performing really well or is in a recession. It tends to sell off in periods when the US economy achieves moderate growth.
The fact that during US recessions the dollar tends to rally, is counterintuitive. It usually happens in times of recession in the US economy, as investors fear the global economy will follow suit. As a result, they buy both US Dollars and US treasuries to protect their capital when a global recession hits, as the US dollar acts as a safe haven.
Furthermore, the US dollar finances the majority of global trade. Hence less global trade can indicate a decrease in circulation of US dollars and a possible shortage of it. The fears of this shortage can also drive the USD price up.
- European Currencies: The European currencies include EUR, SEK, CHF, DKK, and NOK. All of these currencies are highly correlated. The EUR/USD pair determines the USD exchange rate against each of these currencies. For instance, most of the volatility in the USD/SEK comes from the EUR/USD pair in spite of the fact that the EUR/SEK pair influences it. Many people include the GBP/USD pair in the European currencies group. This is mainly due to the UK’s economic links to Europe, although Brexit has dramatically changed the situation for the worse.
- Commodity Currencies: This group includes AUD, NZD, CAD, BRI, CLP, and ZAR and mainly consists of commodity-exporting nations. In these countries, commodity prices influence their respective currencies to a very high degree. The BRL, CLP, and ZAR are all classified as emerging market currencies and each of the countries relies on different commodities. Because of this, there exist several nuances within this group.
For instance, the price of soft commodities drive the value of NZD. Crude oil and natural gas mainly drive the value of CAD, while copper, iron ore, and gold heavily influence the value of AUD.
- Skandies: Skandies is a currency group that includes the DKK, NOK, and SEK and is all Scandinavian economies. They are grouped in a block even though the Swedish and Norwegian economies are quite different. This is mainly because of Norway’s focus on the production of crude oil. Because Finland uses the Euro, it isn’t a part of this group. The DKK is not useful for currency speculation because it’s a free-floating currency which the central bank manages and has a tight band with the Euro.
- Emerging Markets: Also known as EMFX, Emerging markets are a large group of currencies which include the following:
The above list is not an exhaustive one. In this group, the CNH, CNY, KRW, TRY, ZAR, MXN, BRL, SGD, RUB, HUF, PLN and INR are the most liquid and are thus favorites for global speculators.
Most of the currencies in this group are not actively traded. People tend to categories EM currencies into different groups, categorized by fundamentals. This includes groups such as the Fragile Five, the BRICS, etc. However, the groups are mainly faddish and transitory.
Many people also categories them into “crosses”, where one currency is against all others, such as CAD crosses and AUD crosses. For instance, CAD Crosses collectively refer to EUR/CAD, CAD/JPY, AUD/CAD, CAD/NOK, CAD/CHF, etc.
- Managed Currencies: Managed currencies include currency pairs that are not free-floating, such as CNH, CNY KRW, CHF, SG, and RUB. It sometimes includes the JPY as well. Despite these currencies being free-floating, the free market does not completely set their prices.
The central banks of these nations restrict volatility or directional movement at times. As a result, macro speculators find these currencies unattractive because the knowledge of the policy, strategy, and thinking of the central bank is more important than analyzing exogenous macro variables. However, domestic investors who possess inside information have a definite advantage over all other traders.
In this group, currency management is very active. For instance, the PBoC in China, at times, directly influences the value of the CNY through fixings and daily intervention, thereby restraining volatility.
On the other hand, the CHF is a currency whose central bank generally allows it to float freely. It sometimes intervenes if the CHF gains too much momentum due to risk aversion, or has strengthened too much. The SNB, at one point of time, had tried to forcefully weaken the CHF, by putting a 1.2000 on the EUR/CHF pair. However, this experiment eventually failed and the credibility of the central bank suffered as result for years to come. It is hence, not a suitable currency pair for novice traders.
The categorization of currencies into various groups can help traders and investors while analyzing and taking well-informed trading decisions.