Weekly Trades: AUD/USD, AUD/JPY and 18 Currency Pair Analysis

Best description to overall currency market prices last week was balanced, settled, centered, at equilibrium. The same description applies this week to currency prices and it means no dramatic moves are expected and no significant breaks to main averages. Range trading is again the order for the week.

GBP pairs represent slight outliers to balance as GBP/USD again sits on massive supports at 1.2800’s while all GBP cross pair prices are low, oversold and expected to rise significantly this week. Yet any GBP rises are trades within respective ranges.
GBP/NZD offers the best longs along with its counterpart EUR/NZD.

GBP/NZD will outperform EUR/NZD. GBP/NZD is truly an outlier currency pair due to its wide and expansive ranges. It should trade easily at 1.9400’s and 1.9500’s but miniscule ranges to GBP/USD are holding GBP/NZD to trade to its full potential.
GBP/AUD will outperform its counterpart EUR/AUD.

For EUR/AUD will range trade against its main counterpart AUD/USD. No such price exists to EUR/AUD above 1.6400’s. GBP/AUD outperformance is explained by expansion of weekly ranges over the past 3 weeks. GBP/AUD requires a break of many averages at 1.8100’s to move higher.

GBP/CAD ranges this week went dead again and no big moves expected. GBP/CAD ranges expand and contract based on the GBP/USD and USD/CAD relationship. GBP/USD at 1.2900’s and USD/CAD at 1.3100’s warns to a big move ahead and only then will the big trade for GBP/CAD exist. EUR/CAD is the better trade.

GBP/CHF price longer term is low and deeply oversold. It must and will eventually trade to 1.1900’s and 1.2000’s easily. This week however, GBP/CHF price lacks movement ability and will trade in tiny ranges. This means its performing its vital function to act as support to GBP/USD and GBP/JPY to allow both to move higher.

The message from GBP/CHF this week is all CHF pairs as Other Pair/CHF are all overbought. NZD/CHF offers the best and easiest trade for shorts while AUD/CHF and GBP/CHF offers low yet decent ranges. The weekly trades aren’t dead issues but better trade choices exist.

USD/CAD and CAD/JPY are again mis positioned this week. CAD/JPY is a low range currency pair and ,its matched by a good and fairly normal USD/CAD range. Its CAD/JPY mis positioned against USD/CAD.

Most interesting trades this week are JPY cross pairs against Non USD counterparts such as GBP/USD Vs GBP/JPY, AUD/USD Vs AUD/JPY, NZD/USD Vs NZD/JPY and EUR/USD Vs EUR/JPY.

Best combo trade is found in long GBP/USD and GBP/JPY as GBP/USD will be the leader this week to GBP/JPY because its sits on solid supports.

Correlations informs to the JPY cross pair vs Non USD alignments as EUR/USD Vs EUR/JPY run +98%, AUD/USD Vs AUD/JPY run +99%, EUR/JPY Vs AUD/JPY run +98%, This means non USD will run together with JPY cross pairs.

No need ever to run Correlations to GBP/USD Vs GBP/JPY as Correlations rarely if ever break. The GBP/USD Vs GBP/JPY relationship was solidified as one dating to the 1930’s when the BOJ pegged GBP/JPY to Gold.

USD/JPY price is low and oversold from 106.00’s to 108.00’s. For USD/JPY must break 105.81 to move higher to target 106.00’s and 107.00’s. Massive resistance exists at 108.00’s.

EUR/USD is a range trade and balanced this week. Break of 1.600’s changes trend to a lower EUR/USD. EUR contains the opposite line up as GBP pairs. EUR/JPY sits just above a big break point and no threat to EUR/USD breaking 1.1600’s. For GBPUSD sits on big break point to move lower while GBP/JPY price is low and oversold.

NZD/USD price sits just above solid supports at 0.6600’s and 0.6500’s. The averages at supports are many and massive. Only a break at 0.6500’s changes NZD/USD direction to short.

NZD/JPY however trades just above massive supports. No chance for NZD/USD to break 0.6500’s and this allows a combo trade to NZD/USD and NZD/JPY.

If NZD/USD breaks its 5 year average at 0.6809 then much higher for all non USD pairs such as EUR/USD, GBP/USD, and AUD/USD.

AUD/USD contains no chance to break low 0.7100’s this week to change its trend to a lower AUD and AUD/JPY like its counterparts EUR/JPY and NZD/JPY , trades just above supports.

Weekly Trades AUD/USD Vs AUD/JPY


Short 0.7336 and 0.7350 to target 0.7193.

Long 0.7193 to target 0.7279.


Long 75.94 and 76.08 to target 78.11

Short 78.11 to target 76.18

AUD/JPY supports located at 75.46.

As a new week begins, we trade 18 currency pairs continuously without fail from Sunday to Friday or from target to target.



Brian Twomey, Contact brian@btwomey.com





Negative Vs Positive Interest Rates: NZD

The difference between positive and negative Interest Rates is for the most part, nothing. The only change is positive interest rates will work on a negative scale instead of the positive spectrum. Computations are the same except for the negative minus sign.

Overall, negative interest rates are meaningless to FX prices and EURUSD is the prime example, now 6 years in existence. The only possible difference seen is to daily Fx ranges however central banks have this aspect fully covered so FX prices don’t move and to contain prices to tiny ranges. The EUR/USD for example at the 2014 time to go negative contained 75 and 80 pip daily ranges and today, the range was cut by 1/2.

The NZD 5 year Yield went negative -0.02 today from positive 0.01 yesterday. For NZDUSD, the negative rate expanded the overall range 94 Vs 144 pips to be exact but only for the interest Maturity at -0.02. Overall, nothing changed for NZD prices as other maturities compensates for the 1 negative maturity. If all RBNZ rates go negative then nothing changes to NZD.
No difference to interest rate traders except to calculate trades from a negative perspective as ranges remain the same from negative to positive rates.

Used correctly by central banks, negative interest rates is a smarter move than positive rates as positive rate scales conceivably can shoot to infinity while Negative rates contains a known bottom at minus 0.0 and the top side is located at + 0.0, or +0.00 to -0.00. negative rates allow for smaller trade ranges.

For Monetary Policy, negative rates says much more as central banks since 2008 refuse to rescind stimulus and allow GDP and positive interest rates to skyrocket to allow populations and economies to experience economic prosperity.

Negative interest rates informs how much damage was caused over 12 years. Never forget the overall formula as interest rates and money supplies share an adverse relationship and done by central bank design. The more money is added to the system then the more interest rates drop. GDP under stimulus scenarios doesn’t contain any chances to rise to its natural level. Stimulus ensures interest rates and GDP remain lower for longer.

However Monetary Policy under negative interest rates without stimulus is actually a panacea to positive economics as interest and GDP ranges work inside a vast different corridor to overall price systems.

Further reads are Silvio Gesell “The Natural Economic Order” and Knut Wicksell “Interest and Prices”. Anything written by Knut Wicksell is a must read.

NZD/USD now approaches its vital 5 year average at 0.6809. A huge break and commentary to overall market prices as the bottom pair among all 28 informs all other currency pairs will follow NZD’s break. EUR/USD broke at 1.1200’s and GBP/USD is yet to follow at its 5 year average at 1.3196.


Brian Twomey




EUR/USD Day Trade

A person reported on Fxstreet to European interest rates. euribor crossed eonia in some certain way. Well this is useless information to EUR/USD day trade on this day.

EUR/USD From USD Interest Rates day trade today


Long Short Line 1.1766
 most Important 1.1716 and 1.1731 Vs 1.1773, 1.1781, 1.1788, 1.1796, 1.1811, 1.1818 and 1.1826
 Bottom. 1.1706 achieves by 1.1736 and 1.1721
 Upper target 1.1826
 Continuation fail 1.1796
 Break Point 1.1636
                      EUR/USD From ECB Interest Rates today for day trade
Long Short Line 1.1766
 most Important 1.1747 and 1.1755 Vs 1.1773, 1.1781, 1.1788, 1.1796, 1.1811, 1.1818 and 1.1826
 Bottom. 1.1706 achieves by 1.1736 and 1.1721
 Upper target 1.1826
 Continuation fail 1.1796
 Break Point 1.1636
 Difference? 1 pip discrepancy to bottom. ECB has 1.1706 and 1.1707 while USD Fed has 1.1706. negligible.
Most Important 2 bottom points.
USD Fed has minus 50 and 36 pip supports. ECB has minus 19 and 11.
 Break down Fed further, we have 25 and 18 pip supports.
 However, both supports are located within today’s EUR/USD price path so nothing changed to EUR/USD despite the wasted words to Eonia/ Euribor cross over. God help these people
                                      Brian Twomey


Weekly Trade Results: EUR/CAD and EUR/GBP

Weekly Trades as Posted Sunday


1. Short 1.5667 and 1.5682 to target 1.5525.
Highs 1.5655, Lows 1.5527
Target Achieved

Trade Runs +128 Pips

2. Short 1.5473 to target 1.5301.Not traded

3. Long 1.5525 to target 1.5595.

Lows 1.5527, highs 1.5575
Trade Runs +48 Pips.

2 Trades, 3 days +176 Pips.


Short anywhere or 0.9266 if seen to target 0.9051.

Highs 0.9262, Lows 0.9094

Trade Runs +168 pips

3 trades, 3 days, +344 pips.

Note weekly Trades.

No charts, No graphs, No stops, No Fibs, No Indicators

No woulda, shoulda, looks like, maybe, probably, if this then that.

I know exactly what I’m doing as we trade continuous prices up and down or target to target.

Brian Twomey

Weekly Trades: EUR/GBP and EUR/CAD

EUR/GBP is severely overbought from the 5 day average, to the 50 day average, to the 253 day average, to the 5, 10 and 15 year average and to 4000 + day averages.

EUR/GBP overbought informs to the depth and degree of oversold GBP/USD. As mentioned in long term targets, GBP/USD broke big levels at 1.2998, 1.2892 and 1.2859 to achieve current 1.2700. On the way up, oversold GBP/USD must again break 1.2853, 1.2870 and 1.2928 to target 1.3000’s. The lower 1.2700’s GBP/USD drove EUR/GBP higher and this week the reverse will trade.

What allows GBP/USD higher are deeply oversold cross pairs as the GBP universe all now sits together in deeply oversold.
EUR/GBP is normally not a regularly traded currency pair because its a horrible currency and not worth clicks but a fairly easy trade is offered this week.

EUR/CAD is in the same overbought predicament as EUR/GBP and overbought from the 5 day average, 5, 10 and 15 year and overbought from 4000 + day averages. Long term target remains 1.5000’s.


Short anywhere or 0.9266 if seen to target 0.9051.
Short 0.8990 to target 0.8897.
Long 0.8897 to target 0.8959.
Long 0.9051 to target 0.9072.


Short 1.5667 and 1.5682 to target 1.5525.
Short 1.5473 to target 1.5301.
Long 1.5525 to target 1.5595.


Brian Twomey

GBP and Market Crash, Melt downs and Melt Ups

Here’s the trade strategy question related to all trades, weekly and daily. I hark back to Peter Wadkins words. What happens if the market implodes, crashes or melts up or down.  Is the trade strategy factored to all possible scenarios. The question is absolutely.

GBP/USD began the week at 1.3300’s. Here’s the main point to crash, and melt up or downs.

GBP/USD. Break Point 1.2998, below targets 1.2862.

Never expected the market to crash or melt up ow down but absolutely prepared. GBP/USD traded to 1.2772 lows and while we didn’t catch every pip, we caught the vast majority of traded pips.

GBP/JPY began the week at 141.00’s. Never expected a melt up or down but we’re prepared.

GBP/JPY. Break Point 138.54, below targets 137.43. GBP/JPY traded to 135.00’s. We didn’t catch every pip but we caught a vast majority.

GBP/CHF began the week at 1.2100’s. GBP/CHF traded to 1.1600 lows.

GBP/CHF. Break Point 1.2021, below targets 1.1966. We didn’t catch every pip but certainty prepared.

Not accounted was GBP/NZD and GBP/AUD however ironically, EUR/NZD and EUR/AUD this week resulted in good trades.

GBP/NZD and GBP/AUD extremely wide rangers but also becoming problem pairs and both are no associated to EUR/NZD or EUR/AUD.

The melt down for GBP this week and wise preparation compensated for GBP/AUD and GBP/NZD.

Markets and trades are prepared every week to trade normally as this has been the case for the past 3 and 4 years. But now and then an unusual week is seen. Yet unusual circumstances are factored and known at the start of every week.


Brian Twomey


Canada’s CORRA or Canada Overnight Repo Rate Average from October 26 to Sept 4 traded 0.2300 to 0.2500 and a 7 day average at 0.2438.

Canada’s OMMFR or Overnight Money Market Finance Rate from October 26 to September 4 traded 0.2317 to 0.2380.
Canada’s main interest rates trade in correct positions as Corra above OMMFR. No Interest rate changes expected and no warnings or problems seen.

Canada’s Monetary Policy targets Inflation and Employment. Canada’s Inflation Control Target is operational for 30 years and has held Canada in good stead. 2% is the middle bound Vs 1 to 3%. July’s 0.1 Inflation reading contains a trimmed mean at 1.7% and median at 1.9%.

Canada’s latest Inflation tool is to trim Inflation means by discarding highest and lowest readings and include an Inflation Median. Changes are slight and doesn’t appear to impinge on the overall Inflation Control Target formula nor its effects.
As Canada is in the process to understand more fully Inflation Averages in relation to its economy and scheduled for a 2021 final release, 2 interesting developments at the July assessment.

if Inflation is low and allowed to run hot, the effects to Employment was negligible. However this issue will be revisited as Inflation and Employment is the BOE mandate.

One researcher and a concept I favor and use for economic indicators is to obtain a simple averrage for all economics, all releases and assess low and high averages. Its a simple concept and quite easy to run data rather than chart a Keynesian Phillips Curve trade off that may or may not work. New Zealand for example contains about 3500 data points to include 10 and 2 year bond yields and Bank Bill interest rates.

To raise or lower interest rates is assessed by Canada using the Output gap.

Canada’s 2020 Output Gap runs currently 0.042 and only Germany beats by 0.258. Remainder nation run negative Output Gaps as follows: Japan, UK, Europe, France, Italy. The United States runs barely negative but is expected to run positive upon the next GDP release.

Expected for 2021 Canada at 0.015, and a closing Gap while Germany, France, Italy and Europe are expected at 0.17, 0.164, 0.037 and 0.104. A positive Output Gap is the overall economic indicator to raise rates.


The weekly trade we’re currently working on is this for the 2nd and 3rd legs.

2nd and 3rd legs\

Long above 1.3316 to target 1.3506.
Short 1.3262 to target 1.3119

The 1.3262 target achieved at 13258 for +215 pips from 1.3044.

But above is the weekly trade and may not trade today and maybe seen on Thursday or Friday.

Upon the 1.3262 target, USD/CAD traded to 1.3217 lows.

Rather than the weekly trade for the BOC, the day Trade is best. And why is because from 1.3270 to 1.3219 and 1.3115 is a terrible position for USD/CAD to trade the BOC release.

USD/CAD Day Trade


Long Short Line 1.3251

Most Important 1.3196 and 1.3217 Vs 1.3259, 1.3267, 1.3284, 1.3292, 1.3301, 1.3309 and 1.3318

Bottom. 1.3184 achieves by 1.3217 and 1.3199

Upper target 1.3318

Continuation Fail 1.3285

Break Point 1.3322

Above says this from low to high and factored from interest rates.

1.3184, 1.3196, 1.3199, 1.3217, 1.3259, 1.3267, 1.3284, 13292, 1.3301, 1.3309, 1.3318

Note 1.3309 and 1.3318 converges against the break point at 1.3322.

The object for the BOC release is long bottoms and short tops. Don’t expect the overall range to break as this rarely happens. Its free money if ever rare range breaks happen because the price must trade back to its range by central bank mathematical standards. Not mine but central banks as they devised this day trade system.

What this system says overall is the price doesn’t care one iota to what the BOC reveals. They can talk and babble all day and the price system will hold.

One caveat. The BOC is expected to speak at 10:00 and this price system will then run on ECB standards.

So possible to see a slight adjustments to overall prices yet the same concepts hold, short tops and long bottoms for multiple trades and pips.


Brian Twomey



Weekly Trade Results: USD/CAD, CAD/JPY, CAD/CHF

USDCAD Weekly trade As Posted

Long 1.3004 and 1.2991 to target 1.3262.

Lows 1.3044, Highs 1.3234

trade Runs +190 pips

2nd and 3rd legs

Long above 1.3316 to target 1.3506.

Short 1.3262 to target 1.3119


CADJPY Weekly Trade As Posted

Short 81.37 and 81.58 to target 80.29

Highs 81.41, Lows 80.13

target achieved

trade Runs +128 pips

2nd and 3rd Legs

Short below 80.07 to target 79.22

Long 79.22 to target 79.86.

Short 80.29 to target 80.74


CAD/CHF Weekly Trade as Posted

Short 0.7016 and 0.7038 to target 0.6961

Highs 0.7010, Lows 0.6961

target achieved

Trade Runs +49 pips

2nd Leg Short 0.6950 to target 0.6894.

Lows 0.6934 Trade Runs +16 pips

Total +65 pip 

4 trades, 2 days, +383 Pips

Trades still running to Friday


Brian Twomey

Long Term Targets: 20 Currencies

Currency price commonality over the past 3 -4 years was a vast majority of the 28 pairs traded below 5 year averages, weekly trades and targets were 150 to 200 ish pips for 12 and 18 currency pairs and approximately 20 pairs traded miles below its ranges. A few examples.

GBP/USD upon the Brexit drop contained a long term target at 1.3600’s, the second year 1.3400’s and today 1.3200. EUR/USD in 3 years went from a 1.1600’s target to today 1.1400’s. AUD/USD in 3 years contained a target at 0.7800 to today 0.7200’s.

GBP/USD target dropped 200 pips per year, AUD/USD dropped 200 pips per year and EUR/USD dropped about 70 pips per year. All long term targets achieved destinations.

A long term target is a range price and must achieve its location to affirm a normalized price. View a normalized price as a price alignment. For the past 3 and 4 years, a vast majority of currency prices traded under non normal and non alignment status.
The difference between currency prices today from the past 3 to 4 years is most pairs trade within its own respective ranges however just barely.

The difference between a long term target price under non normal status and a price trading within its own range is non normal status offers a target, a direction, a trade, an understanding to price location. The opposite is true to a price within range.

Not known to a range price is a long term target, a direction, a trade yet an understanding to price location. A currency or any market price within range is a settled price and a dead price to trade within respective ranges. A price within its range is surrounded by vital averages and not able to move and a weekly trade that offers about 100 pip trade targets as opposed to 150 to 200 under non normal trade status.

Upon a long term target achievement, the price normally trades a long term reversal to then again re factor a long term target. This scenario highlights non normal markets again. The danger to a long term target completion is the range question as a price has every right to continue within its range or trade a long term reversal.

GBP/USD for example achieved its 1.3400’s target in 2019 then dropped to 1.2000’s and a spike low to 1.1400’s. GBP/USD today at 1.3200’s was the long term target re factored and written in mathematical stone and it doesn”t matter where trade lows are located.

From the 1.3400 target, GBP/USD went from normal to non normal or range to non normal and a 200 pip drop to 1.3200 to its long term target.

20 currency pairs were evaluated to long term model targets. The model is not only exact to pip targets as demonstrated a gazillion times but no need exists to run the model until a target is achieved. GBP/USD for example only required to run the model once per year over the past 3 years. Same for EUR/USD, AUD/USD and a vast majority of currency pairs.

To targets and ranges are trading right at 300 ish pips for most currency pairs.


A deep dysfunction exists between GBP/NZD and EUR/NZD. EUR/NZD trades safely above its 5 year average while GBP/NZD trades below. EUR/NZD averges are dropping while GBP/NZD averages are rising. Short term Correlations run +40% and should run much higher to inform a proper relationship. This won’t happen as GBP/NZD price is low and should trade much higher. Supports are located at 1.9400’s and 1.9500’s and the 5 year average at 1.9456.

EUR/NZD supports are located from 1.6900’s to 1.7200’s and trades within its range below 1.7685 and 1.7640. EUR/NZD’s price should trade much lower and informs a short only strategy far into the distant future.


Short term correlations run +93% and an extraordinary deception. GBP/AUD trades in a 900 pip range and a specific target is found inside its range. GBP/AUD wide range rarely if ever breaks as the price adjusts to overall GBP pairs within the GBP universe. Break of 1.8457 targets 1.8847. Massive supports are located from 1.8000’s to 1.8200’s.

EUR/AUD averages are dropping by the month and currently, EUR/AUD is miles overbought. EUR/AUD targets 1.5974 on a break of 1.6100’s. Above 1.6438 1.6444 and 1.6476, EUR/AUD heads higher to high 1.6500’s and low 1.6600’s. Recommendation is caution to longs above 1.6400 as shorts contain an easier 700 pip trade and because a EUR/AUD price above 1.6400’s doesn’t exist.


Long term target is 1.5019 and EUR/CAD at 1.5400’s is deeply overbought.

USD/CHF and CHF Cross Pairs: Deep oversold

USD/CHF massive resistance across all vital averages at 0.9600’s and all averages are deeply oversold to extremes. Long term target 1.9476.

AUD/CHf. Long term target 0.7030 and deeply oversold

NZD/CHF. Long term target 0.6510

GBP/CHF. Long term target 1.2562

CAD/CHF. Long term target 0.7378

EUR/CHF. Not worth the effort to trade.


Range trades for both. USD/CAD strategy is short only as USD/USD at 1.3000’s should trade miles lower into low 1.2000’s. CAD averages are dropping however slowly. CAD/JPY however meets massive resistance at 83.00’s to 85.00’s.


AUD/USD and AUD/JPY long term target achieved at 0.7200’s and AUD/JPY 78.00’s. AUD/CHF price is low and oversold and the driver pair to higher AUD/USD and AUD/JPY.


A wide range currency pair and no target as GBP/CAD trades in wide ranges and ranges adjust to underlying USD/CAD and GBP/USD movements.


EUR/USD big break 1.1452. Massive resistance 1.2300’s to 1.2500’s.
EUR/JPY range 123.23 to 129.08. Nothing special here.


GBP/USD Big point 1.3205 Vs thick supports and many at 1.2800

GBP/JPY. Big Point 141.74, down from 147.00’s over 3 years or 200 pips per year.


NZD/USD Big Point 0.6724. Range trade and nothing special here.
NZD/JPY. Big break point 71.69 and 71.51.

Best Long term trades: USD/CHF and CHF cross pairs, EUR/CAD, GBP/CHF, EUR/AUD. For CHF cross pairs best are GBP/CHF and AUD/CHF.

Oversold CHF cross provides supports to underlying NZD/USD, AUD/USD, GBP/USD but a far different arrangement to USD/CAD Vs CAD/CHF. USD/CAD is the driver pair to CAD/JPY and CAD/CHF.

All concepts found in levels, ranges and targets.


Brian Twomey


Weekly Trades: USD/CAD, CAD/JPY, CAD/CHF

GBP/JPY will lead JPY cross pairs lower this week. CAD/JPY begins the week overbought while USD/CAD launches from oversold. USD/CAD closed last week at 1.3096 and oversold while this week at the 1.3056 close remains oversold. Included this week is overbought CAD/CHF.

CHF cross pairs arranged as Other Pair/CHF has been running wide ranging to dead week after week. This week is dead ranger. A currency price is dead weekly due to either allow a currency pair within its orbit to perform its necessary porice function or a problem is located within correlations.

CAD/CHF Vs CAD/JPY correlates -25% and +49% to USD/CAD while USD/CAD correlates minus 96% to USD/CAD.

CAD/CHF contains a severe problem to USD/CAD as the correlation should run deeply negative because CAD/CHF is the complete opposite pair to USD/CAD as much as GBP/USD is the total opposite to USD/CAD.

The positive correlation from USD/CAD informs CAD/CHF price runs 50% of USD/CAD. But correct to alignment is CAD/CHF should contain a positive correlation to CAD/JPY and deeply negative to USD/CAD. The CAD universe however is vastly different to its counterparts.

AUD/CHF, NZD/CHF, GBP/CHF and EUR/CHF are bottom pairs with a lower exchange rate price in relation to AUD/USD, NZD/CHF, GBP/USD and EUR/USD.

The Other Pair/CHF purpose is to contain the price to non USD pairs so all don’t trade wildly or theoretically to zero. A non USD pair such as EUR/USD doesn’t have ability to cross below Other Pair/CHF. Instead the price adjusts up or down in relation to non USD pairs.

Overall, USD/CHF and CHF cross pairs as Other Pair /CHF are deeply oversold short, medium and long term. CAD/CHF and AUD/CHF contain the best long term trades for longs.

Deeply oversold CAD/CHF informs USD/CAD potential to trade miles lower is tremendous. USD/CAD averages over time have been dropping however slowly. USD/CAD currently trades between its 5 and 10 year averages from 1.3190 to 1.1893 against most vital averages at 1.2998, 1.2578 and 1.2382. CAD/JPY and CAD/CHF alternatively contain potential to trade miles higher.


Long 1.3004 and 1.2991 to target 1.3262.
Long above 1.3316 to target 1.3506.
Short 1.3506 to target 1.3370.
Short 1.3262 to target 1.3119.


Short 81.37 and 81.58 to target 80.29
Short below 80.07 to target 79.22
Long 79.22 to target 79.86.
Short 80.29 to target 80.74.


Short 0.7016 and 0.7038 to target 0.6961.
Short 0.6950 to target 0.6894.
Long 0.6894 to target 0.6939.
Long 0.6961 to target 0.7004.


Brian Twomey

Weekly Trade Results: GBP/CAD, AUD/USD, USD/CAD

As posted Sunday


Short Anywhere or 1.7498 and 1.7509 to target 1.7291.

Highs 1.7550, Lows 1.7353

Trade Runs +156 pips


Short anywhere or 0.7381 and 0.7394 to target 0.7163.

Highs 0.7411, Lows 0.7264

Trade Runs +130 pips


Long anywhere or 1.3066 and 1.3044 to target 1.3324.

Lows 1.2994, Highs 1.3164

Trade Runs +170 Pips

3 Trades +456 Pips

                 Brian Twomey

EUR/USD and 9 Currency Pair Forecasts

Upon the new 3 month review to my long term model that encompasses our 18 currency pairs traded weekly, nothing changed to EUR/USD.

In June. EUR/USD big break point to trade higher was located at 1.1987, today the big break point remains 1.1987.
Above 1.1987 then next comes the 10 year average at 1.2175 and a break targets 1.2400 to 1.2600’s. However, a total of 10 averages ranging from 1.2400’s to 1.2600’s face EUR/USD above 1.2175. At 1.2600’s represents top of the range to my averages dating to 1999.

The EUR/USD rise from 1.1200’s to 1.1900’s in 15 days was the result of not only a break of its high/ low point at 1.1200’s but the break higher of the 5 year average at 1.1288. EUR/USD was given the green light to move significantly higher.

EUR/USD became the first and leader currency to break its 5 year average. Then next was EUR/JPY at 124.00’s, GBP/USD 1.3216, AUD/USD was next to follow at 0.7282 and NZD/USD is close at 0.6806. USD/CAD broke at 1.3190.

Previously, 24 of 28 currency pairs lived for the past 3 and 4 years trading below 5 year averages.

Moving averages don’t change fast enough to consider or allow 1.2175 will break then trade to 1.2400’s to 1.2600’s anytime soon.

Due to 1.1987 and 1.2175, our strategy changed from long only to short only against a target to 1.1400’s.

Further Reviews

GBP/USD. Big break for lower is located at 1.3352 and this line broke Wednesday. Above 1.3352 then massive resistance is located at 1.3800’s and 1.3900’s. Below then next is the 5 year average now at 1.3218 then solid supports at 1.2800’s. Note 1.3300 ‘s to 1.3800’s is 500 pips and below 1.3300’s to 1.2800’s is 500 pips. We maintain a long drop strategy.

AUD/USD next big lines above are located at 0.7721 and range top at 0.7838. No changes to 0.7838 over the past 3 years as this line hasn’t changed.

AUD/USD big break lower is located at 0.7371 then the 5 year average at 0.7281 and 0.7050. AUD/USD 0.7371 to 0.7700’s is 400 pips and 0.7371 to 0.7050 is 300 pips.

AUD/JPY. 79.82 Vs 76.38. Above 79.82 targets the 5 year average at 80.46 then 81.33. No significant changes for AUD/JPY over years.

GBP/CAD break 1.7285 then the 5 year average targets 1.7000’s.

GBP/CHF Remains significantly depressed and targets 1.2562 easily. GBP/CHF must break 1.2365 to achieve 1.2500’s. Great currency pair and long drop strategy.

EUR/JPY. Lower must break 124.90, 124.82 and 124.68 to target massive supports at 123.00’s. Above 124.90 then EUR/JPY faces 10 averages from 127.00’s to 130.00’s. Higher must break 126.16. No thrills to EUR/JPY.

GBP/JPY higher must break 144.93 then 146.24 and 146.92. Below 144.93 targets 139.00’s and range bottom at 135.00’s. A far better pair to trade as opposed to EUR/JPY and AUD/JPY. Assumption is NZD/JPY will reveal the same small range movement as AUD/JPY. Meaning MA’s are to close to consider big moves.

Overall and a speculation from 8 currency pairs is currency markets are fairly stable again and prices in a decent equilibrium to ranges from 2 to 500 pips.

Further speculation is big moves will be seen in GBP/NZD, EUR/NZD, EUR/CAD, EUR/AUD, GBP/AUD and GBP/CHF. For JPY cross pairs will suffer except GBP/JPY. For USD/CAD was born a wide movement currency pair and significant moves higher are expected.



Brian Twomey


Weekly Trade Review: 18 Currencies

A vast majority of  weeks over the past 4 ish years, no need exists to check entries, targets and results because currency markets were functioning perfectly. This means perfect entries and no questions to targets. Targets remain valid however despite normal vs Non normal markets. Normal weeks, targets always achieve destinations.

It also means a standard weekly 1000 ish pips per week on 10 and 12 currency pairs and 1000 to 1500 on current 18 currency pairs. The EUR/USD rise from 1.1200  to 1.1900’s in 11 days slightly skewed many currency pair prices for about 3 weeks but markets are pretty much back to normal. How do we know?

Entries informs to everything. and concepts to actual definitions to overbought and oversold.

Remember the standard entry formula to entry extremes 20, 50, 100 and 150. This formula doesn’t change across 28 currency pairs and it doubles easily to EM currency pairs.

Example. EUR/NZD and GBP/NZD contained divergence or a mix match to week’s beginning locations. GBP/NZD this week just achieved entry and EUR/NZD overshot by almost 100 pips. Both are now deeply oversold but both are also now in sync.

NZD/USD not much movement this week despite deep overbought as NZD shot higher by just shy of the 13 pip entry  price and in line to the entry formula. NZD/USD against the falling EUR/NZD and GBP/NZD didn’t have ability to drop until EUR/NZD and GBP/NZD aligned properly., an agreement.

Remember trades are weekly and on the 4th day, look out below NZD/USD.

The opposite is true for GBPCAD in the GBP/USD Vs USD/CAD relationship as no divergence exists between GBP/USD and USD/CAD and this allows movements to GBP/CAD. When divergence exists between GBP/USD and USD/CAD then GBP/CAD trades tiny movements. Applies to EUR/CAD.

All GBP pairs began the week in deep overbought yet continued almost a 100 pip rise. The extra 100 pips are free money given freely by the market. Overall, GBP pairs performed beautifully.

Know and understand price paths and Currency pair price relationships is the overall message.

To targets, the commonality to 18 currency pairs over the past 3 weeks is 100 pip movements. This 100 pips applies and will apply to JPY cross pairs except GBP/JPY.

JPY pairs under performed. Upon inspection to the 3 month review  to 18 currency pairs, JPY pairs are stuck and locked up and down by vital MA’s. The best of the bunch is GBP/JPY and NZD/JPY. while AUD/JPY and EUR/JPY are stiffed.

EUR/USD big break 1.1987 then 10 year average at 1.2175. EUR/USD performed this week perfectly due to 1.1987.

EUR/AUD and GBP/AUD on day 4 are working their way higher to weekly targets upon good entries.

AUD/USD and AUD/CHF were good trades and entries but slight miss to AUD/JPY. And quite unusual to AUD/JPY traditionally.

USD/CAD is on the way higher on day 4 but slow price movements higher. Unusual for USD/CAD as USD/CAD contains a free wheeling currency price.

Weekly Trades seen this week is entry anywhere as deep divergence existed between currency pairs. USD/CAD Vs GBP/USD for example. Entries literally didn’t matter as long as the trades were taken in the right directions. Rare for this to happen, especially on weekly trades.

GBP/USD for example dropped so far 117 pips from weekly entry price and 207 pips from market highs. Did entry matter? No

Weekly Trades

Note. Short or Long Anywhere because all our pairs are located at price extremes. Don’t wait for entry just enter and good to enter heavy and expect wide movements this week. Rare opportunity . EUR/USD is good but enter bit higher. Stand clear CAD/JPY and no thrills EUR/JPY. USD/CAD, AUD/USD and all GBP pairs are top picks to weekly list.
AUD/JPY. Break Point 74.91, below targets 73.06.
Strategy. Short anywhere or 77.65 and 78.11 to target 75.82. Must cross 77.42, 77.19, 76.96, 76.73, 76.50, 76.27 and 76.04. Short below 74.91 to target 73.06. Cautious long 75.82 to target 76.74. Long only strategy.
AUD/USD. Break Point 0.7028, below targets 0.6920.
Strategy. Short anywhere or 0.7381 and 0.7394 to target 0.7163. Must cross 0.7354, 0.7327, 0.7300, 0.7273, 0.7246, 0.7219 and 0.7192. Cautious long 0.7163 to target 0.7246. Long only strategy.
AUD/CHF. Break Point 0.6512, below targets 0.6435.
Strategy. Short anywhere or 0.66 5 and 0.6687 to target 0.6531. Must cross 0.6647, 0.6627, 0.6608, 0.6589, 0.6570 and 0.6551. Short below 0.6512 to target 0.6435. Cautious long 0.6531 to target 0.6589. Long only strategy.
EUR/AUD. Break Point 1.6480, above targets 1.6589.
Strategy. Long anywhere or 1.6136 and 1.6127 to target 1.6444. Must cross 1.6172, 1.6208, 1.6244, 1.6280, 1.6316, 1.6352, 1.6388 and 1.6424. Long above 1.6480 to target 1.6589. Cautious short 1.6444 to target 1.6335. Short only strategy.
NZD/JPY. Break Point 69.34, below targets 68.55.
Strategy. Short anywhere or 71.10 and 71.34 to target 69.63. Must cross 70.90, 70.70, 70.50, 70.30, 70.10, 69.90, and 69.70. Short below 69.34 to target 68.55. Cautious long 69.63 to target 70.13. Long only strategy.
NZD/USD. Break Point 0.6504, below targets 0.6391.
Strategy. Short anywhere or 0.6759 and 0.6773 to target 0.6533. Must cross 0.6731, 0.6703, 0.6675, 0.6647, 0.6619, 0.6591, 0.6563 and 0.6535. Short below 0.6504 to target 0.6391. Cautious long 0.6533 to target 0.6618. Long only strategy.
NZD/CHF. Break Point 0.6029, below targets 0.5987.
Strategy. Short anywhere or 0.6103 and 0.6114 to target 0.6031. Must cross 0.6082, 0.6061 and 0.6040. Short below 0.6029 to target 0.5987. Cautious long 0.6031 to target 0.6072. Long only strategy.
USD/CAD. Break Point 1.3371, above targets 1.3513.
Strategy. Long anywhere or 1.3066 and 1.3044 to target 1.3324. Must cross 1.3111, 1.3134, 1.3157, 1.3180, 1.3203, 1.3226, 1.3249, 1.3272, 1.3295 and 1.3318. Long above 1.3371 to target 1.3513. Cautious short 1.3324 to target 1.3182. Short only strategy.
EUR/USD. Break Point 1.1574, below targets 1.1435.
Strategy. Short 1.1956 and 1.1974 to target 1.1713. Must cross 1.1922, 1.1888, 1.1854, 1.1820, 1.1786, 1.1752 and 1.1718. Long 1.1713 to target 1.1852. Long only strategy.
EUR/NZD. Break Point 1.7795, above targets 1.7912.
Strategy. Long 1.7601 and 1.7580 to target 1.7775. Must cross 1.7619, 1.7638, 1.7657, 1.7676, 1.7695, 1.7714, 1.77331.7752 and 1.7771. Long above 1.7795 to target 1.7912. Cautious short 1.7775 to target 1.7639. Weekly strategy.
EUR/JPY. Break Point 123.37, below targets 122.29.
Strategy. Short 125.79 and 126.06 to target 123.90. Must cross 125.52, 125.25, 124.98, 124.71, 124.44 and 124.17. Cautious long 123.90 to target 124.98. Long only strategy.
CAD/JPY. Break Point 79.76, below targets 78.98.
Strategy. Short 80.70 and 80.85 to target 79.92. Must cross 80.54, 80.38, 80.22, 80.06 and 79.90. Short below 79.76 to target 78.98. Long 78.98 to target 79.61.
Favored trades this week: GBP/USD, GBP/JPY, GBP/CHF, GBP/CAD, GBP/AUD, GBP/NZD.
GBP/USD. Break Point 1.2923, below targets 1.2806.
Strategy. Short anywhere or 1.3361 and 1.3391 to target 1.3098. Must cross 1.3332, 1.3303, 1.3274, 1.3245, 1.3216, 1.3187, 1.3158, 1.3129 and 1.3100. Long 1.3098 to target 1.3157. Long only strategy.
GBP/JPY. Break Point 137.76, below targets 136.08.
Strategy. Short anywhere or 140.88 and 140.98 to target 138.77. Must cross 140.47, 140.06,, 139.65, 139.24, 139.03 and 138.82. Long 138.77 to target 139.43. Long only strategy.
GBP/CHF. Break Point 1.1978, below targets 1.1889.
Strategy. Short anywhere or 1.2085 and 1.2102 to target 1.1996. Must cross 1.2068, 1.2051, 1.2034, 1.2017, 1.2001 and 1.1983. Short below 1.1978 to target 1.1889. Long 1.1889 to target 1.1951. Long only strategy.
GBP/CAD. Break Point 1.7270, below targets 1.7187.
Strategy. Short Anywhere or 1.7498 and 1.7509 to target 1.7291. Must cross 1.7478, 1.7458, 1.7438, 1.7418, 1.7398, 1.7378, 1.7358, 1.7338, 1.7318 and 1.7298. Short below 1.7270 to target 1.7187. Cautious long 1.7291 to target 1.7353. Weekly strategy.
GBP/AUD. Break Point 1.8406, above targets 1.8561.
Strategy. long 1.8018 and 1.7979 to target 1.8329. Must cross 1.8056, 1.8094, 1.8132, 1.8160, 1.8198, 1.8236, 1.8274 and 1.8312. Short 1.8329 to target 1.8223. Weekly strategy.
GBP/NZD. Break Point 1.9871, above targets 2.0004.
Strategy. Long 1.9693 and 1.9663 to target 1.9849. Must cross 1.9715, 1.9737, 1.9759, 1.9781, 1.9803, 1.9825 and 1.9847. Long above 1.9871 to target 2.0004. Short 2.0004 to target 1.9938. Weekly strategy.
                   Brian Twomey






Monetary Conditions Index

1. Introduction
Monetary policy affects economic activity and
inflation through a series of channels, which are
collectively known as the transmission
mechanism. Changes in the monetary
authority’s policy rate are generally transmitted
into changes in the market and retail interest
rates, which can affect households’
consumption and saving decisions, firms’
investment and borrowing behaviour and finally
output and inflation. In a flexible exchange rate
economy, changes in the policy rate also affect
the value of the domestic currency vis-à-vis
other currencies, influencing the
competitiveness of domestic exports and
imports, and ultimately affecting net trade and
hence aggregate demand. In addition to this,
exchange rates can also have a direct effect
on consumer price inflation, via domestically
consumed imported goods.

The Monetary Conditions Index (MCI) was
developed in the early 1990s with the aim of
providing information on the stance of monetary
policy taking into account both the interest rate
and the exchange rate channels. It is a
weighted average of the short-term interest rate
and exchange rate. Initially it was used as an
operational target by the Bank of Canada and
Reserve Bank of New Zealand, but
subsequently its role diminished due to
problems in its construction and interpretation,
and it is now used less frequently and only as
one indicator amongst many in monetary policy

With this in mind, it is not the aim of
this paper to contribute to the current
conjunctural monetary analysis, but rather to
discuss the origins of the MCI and to highlight
some limitations and issues relating to its
implementation and use.

With the increasing financial complexity of the
modern economy, growing attention is paid to
how other financial variables including the price
of various asset classes affect the economy.
Moreover, policy makers have placed an
increased emphasis on financial stability
considerations given that changes in financial
variables affect wealth and balance sheet
considerations of various sectors in the
economy. This has led to an interest in the
development of Financial Conditions Indices
(FCI), which seek to provide a simple measure
of how financial market variables impact on the
economy above and beyond the standard
interest rate and exchange rate channels.

However, in many senses the FCI can be seen
as an extension of the earlier MCI. Moreover,
many of the methodological difficulties
associated with the construction of the MCI, as
well as many of the caveats and criticisms, are
also germane to FCIs.

The article proceeds as follows: Section 2
describes the MCI and its construction in more
detail, and identifies possible uses for the
index. Section 3 outlines the various important
issues related to the index regarding both its
methodology and its interpretation, while
section 4 looks at the MCI for some major
economies, and briefly discusses its
movements over the past decade. This article
also includes two boxes: the first provides
greater technical information on the choice of
weights used to estimate unobservable
elements of the MCI, while the second box is
based on a case study of the Canadian and
New Zealand MCI.

2. A description of the MCI

The MCI, which was first developed by the
Bank of Canada in the early 1990s, is
calculated based on a weighted average of
changes in short-term interest rates and
exchange rates relative to some reference
period. It aims to provide information on the
economy and inflation for monetary policy
analysis. A change in the index indicates how
‘tight’ or ‘loose’ monetary conditions in the
economy are, relative to a certain reference

The most obvious benefits of the MCI are that it
is straightforward, easy to understand, and, in
the past, was seen as a better indicator than
just focusing on interest rates, given the role of
the exchange rate in the transmission
mechanism. Even though it was used by
central banks, international organisations, as
well as financial corporations in different ways
over the years, it has various shortcomings.

It is
difficult to operationalise given that it combines
a monetary policy tool (interest rate) and a
macroeconomic outcome (the exchange rate)
and a lot of judgement is required for its

A Discussion of the Monetary
Condition Index 70 Quarterly Bulletin 01 / January 10

2.1 Definition

The basic formula for the MCI is as follows:
MCI = −[θ1(Rt − R*) + θ2 ((et − e*) × 100)]
(Equation 1)

• Rt represents the level of the short term
interest rate, and et is the log of the
effective exchange rate at a particular
point in time t

. If e increases it implies
that the domestic currency is
appreciating. Either real or nominal rates
for each of these variables can be used.
Short-term money market rates are used,
as they are closely aligned to the policy
rate, and the decisions by monetary
authorities transmit quickly into these

• The asterisk denotes the reference level
of each of the respective variables. In
theory, the reference or base levels for
the variables should reflect ‘‘neutral’’
economic conditions, but in practice this
is difficult to operationalise, hence a
simple average over a period of time is
generally used3

. Rather than focusing on
the absolute levels of the variables,
changes in the variables with respect to
this base level are used. If the (Rt − R*)
or respectively the (et − e*) component is
positive it means that the current interest
rate, or respectively the exchange rate,
is higher than that observed on average
during the reference period.

• The weights applied to interest and
exchange rates, θ1 and θ2 respectively,
typically add up to unity. The ratio θ1/θ2
reflects the relative impact of the interest
rate and exchange rate on the economy
as measured by either aggregate
demand or prices, although the former
method appears to be much more 2

The short-term rate usually employed is the 3-month interbank
rate, and the effective exchange rate is a weighted average of
bilateral exchange rates against major trading partners.

difference in the log of the exchange rate is mulitplied by 100 in
order to express it as a percentage. 3 Ideally, optimal or equilibrium levels of the interest rate and
exchange rate could be used, estimated from a Taylor type rule or
an equilibrium exchange rate model, but in practice these are
exceptionally difficult to accurately estimate.
prevalent in the literature4

. Therefore, if
there is a rise of θ1 percentage points in
the interest rate, it will have the same
effect on the policy goal as a θ2 percent
appreciation of the domestic currency,
so that a larger ratio will mean a weaker
overall affect of the exchange rate in the

There are a number of possible
methods to derive these weights, which
are outlined in Box 1.
• Finally, a negative sign is usually
attached to the overall computation of
the index so that, when there is a
decline (increase) in the index, as
defined by Equation 1 above, it indicates
that monetary conditions have tightened
2.2 Possible uses

In the implementation of policy, monetary
authorities focus on a number of variables, from
the ultimate target (frequently inflation) at one
end of the spectrum to the policy instruments
(such as the short-term interest rate) at the
other. Due to long lags and the indirect
connections between the target and the
instruments, monetary authorities resort to
operational targets6
, information variables and
indicators that link the two.

These intermediate
variables or targets are closely linked to the
ultimate target and are influenced by changes
in the policy instrument (Freedman, 1994). The
MCI falls within this group of intermediate
measures, and can be used as an indicator or
operational target in the conduct of monetary

When the Bank of Canada developed the MCI
in the early 1990s, it was used as an
operational target in the design of monetary
policy, and was then subsequently used in the
same way by the Reserve Bank of New

4 Some commentators criticised the practice of deriving the weights
from an aggregate demand function when the overall target was
inflation, as was the case in Canada and New Zealand.

one of the reasons for focusing on aggregate demand is,
‘‘because it is the output gap, along with expected inflation, that is
the principal driving force behind increases and decreases in the
inflationary pressures and it is changes in aggregate demand that
are a key determinant of changes in the output gap’’ (Freedman,

5 The rationale for the negative sign is that tighter monetary
conditions generally bear down on activity levels and looser policy
generally does the reverse.

6 The operational target of monetary policy is an economic variable,
which the central bank aims to control by use of its monetary
policy instruments. It is the variable the level of which the
monetary policy decision-making committee of the central bank
actually decides upon in each of its meetings (Bindseil, 2004).

A Discussion of the Monetary
Condition Index

Quarterly Bulletin 01 / January 10 71

Box 1: Calculating the MCI weights
The MCI, as outlined in Equation 1, contains certain unobservable elements that
need to be estimated, namely the reference levels for the interest and exchange
rates, and the weights attached to deviations between these variables and their
respective reference levels. Overall, the size of θ1/θ2 should capture the effect of
percentage point changes in the interest rate relative to a percentage change in
the exchange rate and its accuracy is conditional on the particular model used
for estimation. This box reviews the different methods used in the literature to
estimate the weights.

Batini and Turnball (2002) posit that there are
three main methods for estimating the MCIs’

Single Equation based MCIs

One of the most common ways of deriving the
weights based on the above rationale involves
estimating an aggregate demand function,
similar to the following:

∆yt = α ∆ Rt + β ∆ et + x + error

Where ∆ is the first difference operator which
captures the change in the variable over time1
y is Gross Domestic Product (GDP), R is the
interest rate and e is the exchange rate.

subscript t refers to the current or latest time
period. Overall, this function seeks to discover
the effect of changes in interest rates,
exchange rates and other economic variables,
represented by x in the equation above (i.e.
current and lagged values for GDP of main
trading partners), on GDP.

From this equation,
α and β, the partial derivatives of the interest
and exchange rates respectively, can act as
the weights θ1 and θ2, so that the ratio of the
coefficients in equation 1, θ1/θ2, equals the ratio

Multiple Equation based MCIs

There are also more elaborate multiple
equation-based methods. These methods
involve estimating and simulating structural
macro-econometric models in which the
weights are then obtained from a system of
equations rather than just one.

The weights can
also very often be estimated using vector
autoregressive models (VARs), with time series
of GDP, exchange rates and interest rates.

Subsequently, impulse response functions
(IRFs) are derived. The IRFs measure the
response of GDP to individual shocks in both
the interest rate and the exchange rate.

weights θ1 and θ2 are then based on a
cumulative average responsiveness of GDP to
shocks in the interest and exchange rate
respectively over a certain number of quarters.

A critical element in the use of this approach is
the correct identification of shocks to the
relevant variables.

Many banks and
international organisations use the weights
estimated from existing structural
macroeconomic models, for example the OECD
bases its weights on results from their Interlink

MCIs based on large macroeconometric models, especially those that
contain a monetary policy reaction function, are
more instructive as they take account of more
features of the economy.

Trade share based MCI

This final method is simpler to calculate. The
exchange rate weight is based on the long run
exports-to-GDP ratio and the interest rate
weight is simply one minus this ratio.

rationale is that this net trade component
captures the effect of the exchange rate on
GDP relative to interest rates.

However, it is
used less frequently given the simplicity in
relation to the estimation of the weights and,
consequently, the lack of detail about the
effects of the relevant variables on the

Overall, the multiple equation based model is
generally deemed to be optimal, as it takes
account of the cumulative lagged impact of the
different variables.

The dynamics of the
underlying model are very important; a model
that takes account of the different lags at which
an economy responds to changes in interest
rates and exchanges rates would perhaps
deliver a more accurate index. If a model is too
simple, or fails to take into account key
characteristics of behaviour, the measurement
of the weights can be flawed, meaning that the
MCI itself is built on erroneous foundations.

The operator is defined as ∆yt = yt − yt−1, which is the change in
GDP from the previous period.

A Discussion of the Monetary
Condition Index

72 Quarterly Bulletin 01 / January 10
Zealand between 1997 and 1999 (see Box 2).

The rationale for adopting this policy was that it
may be difficult to predict the response of the
foreign exchange market to a change in the
policy rate (Gerlach and Smets, 2000).

theory of uncovered interest rate parity7
suggests that interest rates and exchange rates
are related in a systematic way, although
empirically this relationship does not always

Hence, there is still no completely clear
understanding of the interaction between
interest rates and exchange rates.

Above is wrong

The method used in the case of the operational
target, which was particular to these two
countries, involved having an inflation target8
and deriving a solution for future interest rates
and exchange rates consistent with the target
after having taken into account domestic and
foreign economic conditions.

Using these
projections the bank was able to derive the so called ‘desired’ MCI level, which could
represent a range of values rather than point

The forward-looking focus of this
approach took into account the lags between
the monetary policy stance or changes in it and
the effect on the rate of inflation9

. If the actual
level of the MCI deviated from the desired
path, the Bank would use the tools at its
disposal (for example, the overnight rate) to
adjust the index accordingly.

It is important to note that using the MCI as an
operational target does not imply an automatic
reaction to all exchange rate changes, since
the target level of the MCI varies in response to
shocks that affect the exchange rate.

In the
case of an aggregate demand shock, the
desired level of the MCI will change, whereas if
there is a credibility shock, the target MCI level
should remain unchanged ceteris paribus.

Charles Freedman, the deputy Governor of the
Bank of Canada at the time put it,
‘‘A lot of judgement goes into it, and there
is a lot of cross-checking against important
information variables such as the rate of
growth of monetary aggregates10’’.

7 The theory of uncovered interest rate parity states that ‘‘the
exchange rate against a foreign currency deviates from its
expected value at some future time by the size of the interest rate
differential (over the appropriate horizon) with that country’’
(Stevens, 1998).

8 Canada had an inflation range of 1-3 per cent and New Zealand
had a target of 0-3 per cent. 9 For Canada, Freedman (1995) estimated that monetary actions
would influence the rate of inflation in about 6 to 8 quarters ahead.

10 Excerpt from remarks made by Deputy Governor Freedman to the
Conference on International Developments and Economic
Outlook for Canada, 15 June 1995.

The use of the MCI as an operational target
diminished over time, due to pitfalls that
emerged when the index was used in this
capacity. In particular there was great
uncertainty regarding the source of exchange
rate movements. A more detailed look at these
problems in Canada and New Zealand, are
discussed in Box 2.

With the MCI’s relevance as an operational
target declining, it has increasingly been used
as an indicator in monetary policy analysis.

this capacity, monetary policy tools are no
longer used to adjust the level of the index to a
desired path, but rather it merely helps to
inform policy makers of the current stance of
monetary conditions, and whether they are
tighter or looser relative to other periods.

3. An evaluation of the MCI

The MCI presents some problems both at the
level of construction and in terms of its
conceptual and empirical foundations, which
are outlined in this section.

3.1 Methodological Issues in constructing

In constructing a MCI, an initial technical issue
is to determine the appropriate weights.

the weights of the components are not directly
observable, but are based on econometric
estimates, they are highly sensitive to the
model used (see Box 1) — i.e. the MCI ratio
can suffer from model uncertainty.

The main
pitfalls involved in deriving the weights
therefore, vary between the models used and
are consequently model dependent.

principal problems include capturing the
correct dynamics of the relationship, as interest
rates and exchange rates can affect the
economy at different speeds, and parameter
constancy, which requires that the coefficients
from the models used to calculate the weights,
must not change depending on the time period

11. If these problems are not adequately
dealt with, the weights that are derived risk
being erroneous and may provide an
inaccurate picture of monetary conditions (Eika
et al. (1996) and Batini and Turnball (2002)).

11 For a further and more detailed discussion of the econometric
problems involved in calculating the MCI weights please refer to
Eika et al. (1996) and Batini and Turnbull (2002).

A Discussion of the Monetary
Condition Index

Quarterly Bulletin 01 / January 10 73

Box 2: MCIs as an operational target — problems in practice

A number of difficulties and challenges emerged during the period in which the
MCI was used as an operational target by both the Bank of Canada (BoC) and
the Reserve Bank of New Zealand in the 1990s.

Some examples of these
problems are highlighted in this box.

While the MCI appeared to be attractive as an
operational target for the BoC, it became
evident that there were a number of

Firstly, there was a tendency on
the part of some observers to treat the MCI as
a precise short-term target for policy, while the
Bank indicated that it should not be treated as
a narrow, precise measure.

Secondly, the
markets started to treat all exchange rate
movements as portfolio readjustments on the
part of investors (portfolio shocks) and,
therefore, came to expect an offsetting interest
rate adjustment every time there was a
movement in the exchange rate, whether or not
such an adjustment was appropriate.

addition, the central bank itself had to make a
judgement on the source and likely persistence
of the shock to the exchange rate, in order to
decide on the appropriate response.

this caused problems in 1998, when the rapid
depreciation of the Canadian Dollar produced
accusations of a myopic central bank (Robson,
1998), whereas the BoC argued that the
depreciation signalled looser than desired
monetary conditions that warranted sharp
increases in the policy interest rate.

Given the difficulties mentioned, less emphasis
was placed on the role of the MCI as a
Related to this, even if the model for deriving
the weights is correctly specified and manages
to accurately capture the effects of the interest
rate and the exchange rate on the economy,
over a certain period of time, there is always
the possibility that the monetary transmission
mechanism itself (the effect of the interest rate
and the exchange rate on output) can change
over time for a variety of reasons.

Therefore it is
vital to monitor this system and ideally to
ensure that any changes to how monetary
impulses are transmitted to inflation are
recognised in the MCI. In practice this may be
difficult to achieve.

measure of monetary conditions in the late
1990s and the early part of the current decade.

Subsequently, the MCI was discontinued from
being published by the BoC (2006), and has
not been used as an input into monetary policy

Problems also emerged in New Zealand over
the period when the Reserve Bank of New
Zealand employed the MCI as an operational
target (mid-1997-March 1999).

In particular,
interest rates were increased as an automatic
response to a depreciation of the New Zealand
Dollar (NZ$), with little evidence that those
interest rate increases were warranted.

As a
result, interest rates were increased at a time
when a serious drought caused severe water
shortages in New Zealand, the Asian crisis
evolved (1997/1998) and as output growth in
the country turned negative.

Given the
circumstances, this may not have been the
most appropriate action.

Following the
difficulties encountered, the Reserve Bank of
New Zealand subsequently acknowledged that
they ‘‘were slow to recognise the joint impact of
the Asian crisis and the beginning of an
extended drought through 1997 and early
1998’’. They subsequently discontinued using
the MCI in this capacity.

A further technical issue is whether MCIs
should be calculated in terms of real or
nominal variables.

Theoretically, it would seem
preferable to express the MCI on the basis of
real variables as the real MCI takes account of
inflation movements. It is also generally
believed that rational agents consider the real
rather than nominal rates in their consumption
and investment decisions.

However, there is
evidence that individuals can suffer from
money illusion whereby they consider the
nominal rather than the real variables in their
decision making (Akerloff and Shiller, 2009)
(Fehr and Tyran, 2001). Peeters (1999) and
Gerlach and Smets (2000) also put forward the
A Discussion of the Monetary
Condition Index

74 Quarterly Bulletin 01 / January 10
argument that economic behaviour often reacts
on the basis of nominal interest rates in the
short run. Furthermore, the nominal MCI seems
to be a reasonable approximation for the real
MCI in the short run, in the context of a low
inflation environment. See Costa (2000b) and
the ECB (2002).

There are also other factors justifying the use of
nominal variables.

For example, a nominal MCI
may be easier to construct and is also timelier
as inflation data needed for the real measure
are only available on a monthly basis, as
opposed to the daily availability of nominal
interest and exchange rate data.

However, it
should be noted that in a period of high
inflation, the nominal index is likely to show
more pronounced tightening than the real

The selection of the MCI components is also
an issue that has received more attention in
recent years.

Since the MCI components
should be in line with the nature of the
monetary transmission mechanism and with the
appropriate structure of the relevant economy,
it has been argued that other factors, such as
long-term interest rates12 and asset prices (i.e.
house prices and stock prices), should also be
included in the MCI.

For the euro area, long term interest rates play an important role in the
monetary transmission mechanism, as
investment and consumption behaviour is often
dependent upon long-term rates.

Taking into account the increasing debate over
the role played by asset prices in the monetary
transmission mechanism, through wealth
effects and balance sheet effects, the Financial
Conditions Index (FCI) has been developed in
recent years.

Policy makers and international
organisations often use the FCI in their
assessment of the monetary policy stance.

However, the definition of FCIs differs across
methodologies. While some researchers
compute FCIs that measure the
tightness/accommodativeness of financial
factors relative to their historical average in
terms of an effective policy rate (e.g. Guichard

For countries in which long-term financing relationships play a
major role, it would be logically consistent to include a long-term
interest rate. Fixed long-term interest rates exert a larger
influence on consumption and investment decisions in several
countries in Continental Europe, relative to the Anglo-Saxon
countries (Costa, 2000).
and Turner, 2008),

others measure the
estimated contribution to growth from financial
shocks in a given quarter (Swiston, 2008).

The FCI extends the MCI approach by
including other financial variables, including
stock prices, asset prices and long-term
interest rates13, but similar to the MCI, the index
still suffers from certain criticisms, such as
model dependency, ignored dynamics and
parameter inconsistency.

While a full
discussion on such an index is beyond the
scope of this article, a number of interesting
findings are worth noting.

Based on research at
the BoC, which suggested that asset prices
may offer important information about future
inflationary pressures, Gauthier, Graham and
Liu (2004) estimate a number of FCIs for

They find that the FCI outperforms the
MCI in many areas, and also that house prices,
equity prices and bond risk premium, in
addition to short and long-term interest rates
and the exchange rate, are significant in
explaining output in Canada.

Goodhart and
Hofmann (2001), also find that house and share
prices are important variables in such an index
for G7 countries, and that the FCI contains
useful information about future inflationary

A more recent example of the FCI’s
use is illustrated in a recent paper by Beaton,
Lalonde and Luu (2009).

It looks at the
development and increasing importance of
financial conditions in the US during the current

They find that financial conditions have
had a large negative impact on US GDP
growth in the current recession14 and that the
monetary easing undertaken by the Federal
Reserve over the recent financial crisis has not
been sufficient to offset the tightening of
financial conditions.

A final point related to the selection of the
components is that neither money nor credit
plays a role in standard representations of a

For example, the same level of a MCI
could be consistent with various rates of
monetary growth, and in no way calls into
question the importance of the money supply in

More recently, lending standards have also been included in
FCIs to account for non-price credit conditions (Guichard and
Turner, 2008).

14 Their FCI suggests that financial factors subtracted between 4
and 7 percentage points from quarterly annualised growth in
2009 Q1.

A Discussion of the Monetary
Condition Index
Quarterly Bulletin 01 / January 10 75

the economy or ultimately the monetary nature
of inflation.

This is particularly relevant when
there are quantity constraints or credit
rationing. Given these shortcomings, the MCI
should be interpreted with caution regardless
of whether it is being used as an operational
target, or merely as one indicator among

3.2 Interpretation Issues

Irrespective of the difficulties in constructing a
MCI, interpreting changes in it in terms of their
significance for current monetary policy is not

Whether it is appropriate or not for a
central bank to make a policy change in
response to a change in the MCI (in the case
of the MCI being an operational target)
depends on the factors underlying changes in
the components.

A given movement of the MCI
may have different consequences in terms of
the final policy objective.

In particular, it is
important to determine the nature of shocks
causing movements in the exchange rate, and
not mechanically follow movements in
individual components, as highlighted in the
case of New Zealand in Box 2.

Siklos (2000) believes that the simplicity of
MCIs implies a loss of information when the
effects of the component variables are
aggregated, as it can obscure the movements
of the individual components.

King (1997) also
makes the point that ‘‘any attempt to construct
a simple monetary conditions index is akin to
adding together apples and oranges’’,
particularly given that the exchange rate is not
a policy instrument and therefore MCIs mix
variables that are not of the same nature.

Given the difficulty in determining whether any
particular reference period is ‘‘neutral’’ (Banque
de France Bulletin Digest, 1996), most
implementations focus on changes in the index
compared with previous periods, to ascertain if
monetary conditions have tightened or
loosened, rather than looking at the absolute
levels of the index.

It is important to note that
historical averages do not necessarily
represent neutral conditions and furthermore,
structural changes in the economy and
differences in cyclical conditions may also
affect what is understood as neutral conditions.

4. Constructing the MCIs

The following section focuses on developments
in MCIs for the euro area, the UK and the US
over the past decade.

It is important to
emphasise that the purpose of this section is
not to speculate as to which weights may be
best or even to assess the extent to which the
MCIs portray an accurate picture of the
monetary stance.

For each country, there are many plausible
alternative weights specified by various
institutions and academics.

The choice of the
weights can affect the overall level of the index
and also the rate of change of the indices.

this analysis, a weight of 6:1 is used for the
euro area, which is used by the European

and weights of 3:1 and 10:1 are
used for the UK and the US respectively.

latter weights have been applied by the IMF in
the past.

In terms of the data used in the
construction of the MCI for each country/area,
the short-term interest rate is proxied by the
three-month money market rate while a broad
trade weighted exchange rate proxies the
exchange rate variable.

These series are then
deflated by consumer price indices16.

the base/reference periods refer to the average
of both interest and exchange rates from 1993
to present.

4.1 MCIs in Practice

Referring to Chart 1, it is evident that over the
sample period (1999-2009) for the euro area,
there appears to have been a marked
tightening in monetary conditions post 2005,

which is consistent with increasing interest

Despite the significant economic
developments since the financial crisis, the
MCI, while volatile, has not shown any
substantial changes in its trend.

Meanwhile, the
MCI for the UK shows its only major shift in
trend from around 2007 on.

At this point both
interest rates and exchange rates contributed
to looser monetary conditions.

The movement
of the US MCI during the sample period has
been more variable, and has tended to track
changes in the interest rate, given this

15 This ratio was derived from simulations of the OECD Interlink
Model. 16 Ex-ante real short-term interest rates were also calculated (using
inflation 3-months forward), but the results were very similar.


Brian Twomey

Taylor Rules Vs Monetary Conditions Index

Forgot to include to the Average Inflation Target article.

The previous model to Taylor Rules was the Monetary Conditions Index. Both were designed to assess where is the appropriate level of the Fed funds Rate yet applies to any nation to determine the correct level of Interest rates.

Fed Funds vs Taylor Rules correct level: 1.207

Taylor Rules to determine the correct rate of the 90 Day Interest rate. 1.94

So 1.20 and 1.94 Vs Headline 0.25 and current overnight Rate 0.08

Taylor Rule Calculations


Target = Inflation + 0.5 X (Inflation – Inflation) +0.5 X (GDP Minus GDP) + Interest (Overnight rate)


Taylor Rules 90 Day Rate

Target = 90 Day Rate + Inflation Target + 1.5 X (Inflation – Inflation) +0.5

Technically the Output Gap supposed to include as the last term but its not necessary.

Monetary Conditions Index


The Monetary Conditions Index gauges the level of the interest rate and Exchange Rate to the Trade Weight Index. Its a fabulous tool and reveals much. See the EUR chart below. We don’t hear about MCI anymore but we hear about Taylor Rules yet its a vital tool.


Monetary Conditions Index EUROPE

Click to access mci.pdf


Click to access confp06i.pdf

Click to access confp06i.pdf

Weekly Trades: AUD/USD, USD/CAD, GBP/CAD


Short anywhere or 0.7381 and 0.7394 to target 0.7163.

Long 0.7163 to target 0.7246


Short Anywhere or 1.7498 and 1.7509 to target 1.7291.

Short below 1.7270 to target 1.7187.

Long 1.7291 to target 1.7353.


Long anywhere or 1.3066 and 1.3044 to target 1.3324.

Long above 1.3371 to target 1.3513.

Short 1.3324 to target 1.3182


Brian Twomey