Long term FX trends point to gradual currency realignment

January 21, 2026 (MLN): Currency valuations play a critical role in shaping long-term movements in the foreign exchange market, even though they are often overlooked by short-term traders.

While exchange rates can remain misaligned with fair value for extended periods, large valuation gaps tend to create correction pressures over time.

The wider the deviation between spot prices and fair value, the stronger the potential pull back toward equilibrium, making valuation an important consideration for long-term FX planning.

Unlike equities or fixed-income assets, currencies do not generate future cash flows, which rules out traditional discounted valuation methods. Instead, long-term FX valuation relies heavily on purchasing power parity (PPP), which assumes that similar baskets of goods and services should cost comparable amounts across countries.

When significant deviations from PPP occur, adjustments typically take place through exchange rate movements, although sustained inflation differentials can also drive the correction process over time according to HSBC Currency and Commodities Outlook.

Long-term FX forecasts are designed primarily as planning tools rather than precise predictions. While shorter-term forecasts generally cover an 18–24 month horizon, extended projections provide directional guidance further into the future.

These longer-term assumptions are based on a gradual convergence of exchange rates toward their estimated equilibrium levels, recognizing that currency misalignments can persist for years before meaningful corrections materialize.

The methodology underpinning long-term forecasts assumes that exchange rates move progressively from near-term projections toward their PPP-based fair values.

This convergence is modeled with a five-year half-life, meaning that by the end of the forecast horizon in 2031, exchange rates are expected to close roughly half the gap between short-term forecasts and long-run equilibrium levels.

This approach shows the slow-moving nature of valuation forces in currency markets.

FX markets in December 2025 were dominated by policy-driven movements, particularly in the US dollar.

The USD weakened during the month amid uncertainty over Federal Reserve leadership and a less hawkish policy outlook, with the DXY index ending December lower despite stabilizing toward month-end.

The euro strengthened against the dollar, supported by stable European Central Bank policy expectations and broad USD softness, while the British pound posted gains as it remained resilient to post-budget political noise and responded to mixed but generally supportive domestic data.

Elsewhere, the Canadian dollar benefited from broad USD weakness and stronger domestic employment data earlier in the month, although gains moderated toward year-end as US dollar dynamics stabilized.

Overall, major currency moves during December showed shifting monetary policy expectations rather than valuation-driven adjustments, emphasizing the dominance of short-term factors in FX markets.

To assess long-term valuation signals, the HSBC Little Mac Valuation Range methodology uses real effective exchange rates across multiple historical time windows of at least five years.

By comparing current exchange rates to a wide range of PPP estimates rather than a single reference point, this approach provides a more robust framework for identifying meaningful overvaluation or undervaluation in currency pairs.

Looking ahead, long-term FX forecasts highlight the importance of valuation as a slow but powerful force in currency markets.

While short-term volatility will continue to be shaped by central bank policy, economic data, and geopolitical developments, sustained deviations from fair value are likely to influence currency direction over the longer run, making valuation-based analysis a useful complement to near-term market signals.

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