In other words, the answer is also temporal; it depends on the time horizon. Are we looking at the exchange rate changes over the short term, such as the last three months, or the very long-term trend over decades? Arguably, different key factors affect exchange rates over the short term (minutes to a few months), medium term (a year to a few years) and the long term (up to decades).
And given the value transacted each day — by some of the most sophisticated investors, bankers and money managers — one must assume that the exchange rate at the moment in time is the “right” relative price of one currency for another that reflects their purchasing power across borders, adjusted continuously in global markets to balance supply and demand for those currencies. Remember, currencies have no intrinsic value, but only as a pure medium of exchange.
Although the story of George Soros breaking the Bank of England is one of the most famous currency-trading episodes in history, many who bet against the exchange rates have made huge losses. The Japanese yen (JPY) carry trades, where hedge funds borrowed in JPY and invested elsewhere, were caught when the JPY rallied. And, in Malaysia in the late 1980s and early 1990s, Bank Negara Malaysia conducted aggressive foreign-exchange intervention and lost RM32 billion. The main takeaway is even the best and most sophisticated investors, analysts and economists have little understanding of all the variables that drive exchange rates. It pays to be humble.
We decided to write this two-part series (which we struggled quite a lot with and are aware that some people will be offended by) because this simple question is one of the most difficult to answer. It is certainly not something we can articulate in a five-minute conversation, without missing context, missing premises, oversimplifying and being a reductionist. Besides the fact that there are many economic and financial factors, one often contradicting another, exchange rates are also driven by momentum, expectations, narratives and sometimes by interventions. In other words, there will always be many views. Having said that, we will be as comprehensive as we can. We will provide the data and analytics, and we are NOT claiming to be right — only to offer a reasonable framework to help you decide.
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So, what factors determine exchange rates? In the interest of making this article more readable for most of our readers, we have moved the more technical details and a comprehensive discussion to the accompanying sidebar (see “Why exchange rates fluctuate”). We summarise here the key drivers that affect exchange rates in the short, medium and long term.
We believe exchange rate drivers across time horizons are very important, yet hardly discussed. Table 1 provides a useful guide in explaining the factors that are driving exchange rates — especially when seen in the context of a defined time horizon, which is how we view exchange rate fluctuations. Otherwise, we risk confusing the short-term outlook with the longer-term one, or mistaking longer-term drivers for short-term outcomes. More critically for policymakers, it is essential to stay focused on the long-term drivers so that the objective of a stronger ringgit can be sustained. The greater risk is to be carried away by short-term strength — driven by volatile and less predictable factors — and mistakenly believing that long-term objectives are being realised.
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Short-term strength in the ringgit
Our article this week will focus only on the ringgit’s performance over the last 12 months, particularly over the last three. We will highlight what we believe are the key drivers and why. It is the simpler section of our thesis. Next week, we will address the question of sustainability of the current ringgit trend — that is, the longer-term trend of the ringgit.
The ringgit has strengthened against the US dollar (USD) by about 7.8% over the past 12 months, the Singapore dollar (SGD) by 4.5%, the pound sterling (GBP) by 3.2%, the Australian dollar (AUD) by 7%, the JPY by 8.1% and the renminbi (RMB) by 5.9%. It declined by 2.1%, however, against the EUR.
This is the first interesting observation. Over the past 12 months, the EUR has performed better than most other currencies. Why? The big-picture economic view of the eurozone is stagnant growth and a dramatic fall in inflation. It is one of the world’s weakest-performing major economic blocs. Germany, in particular, is the “sick man”, weighed down by high energy costs and weak global demand for its manufactured goods and elevated interest rates. While headline inflation numbers fell from 8.5% to 2.4%, core inflation (excluding energy and food) remains sticky. The European Central Bank (ECB) raised its key interest rates to a record-high 4% in September 2023 to combat inflation.
So, why is the EUR so strong, despite its very weak economy? Lesson One: The short-term currency strength may have nothing to do with current economic growth.
ECB has been more aggressive than the Fed in cutting rates. Table 2 shows the Fed and ECB rates by quarters. ECB reduced interest rates from 4% in 2Q2024 to 3.5% by 3Q2024, 3% in 4Q2024, 2.5% in 1Q2025 and, finally, to 2% from 2Q2025. The Fed held interest rates at 4.5% from 4Q2024 to 3Q2025 (after the 1% reduction in 3Q2024). It then reduced rates by 25 basis points (bps) in each of the following two quarters.
For more stories about where money flows, click here for Capital Section
Lesson Two: Despite ECB’s aggressive interest rate cuts, which would normally weaken the euro, the currency actually strengthened.
Exchange rates are a funny thing. It is easy to explain movements in hindsight, but almost impossible to predict them in advance. Yes, the forex market is influenced by multiple factors, often pulling in opposite directions, rather than by any single variable. And, yes, it is driven more by expectations than known facts. Put another way, the exchange rate at any moment in time has factored in all the “known” and its movements from this point will be driven by expectations of the future.
Therefore, a rational and reasonable explanation for the strength of the EUR in the last three months is that the earlier interest rate cuts had already been implemented, and no further cuts or surprises are expected, given that rates have stood at 2% since 2Q2025. This contrasts with the Fed, which cut rates more recently — from 4.5% in 2Q2025 by 25bps each subsequent quarter — and is expected to implement further cuts, favouring the EUR against the USD.
The expected US-EU real yield differential narrowed (because of the expected fall in Fed rates). What matters is not the spot policy rate, but the expected forward rate.
Another widely cited reason is the large speculative short positions on the EUR three to four months earlier. The unwinding of these positions requires traders to buy the EUR.
But the longer-term trend is quite a different story. Unless the eurozone can restore its competitiveness again, expand manufacturing exports (which will be tough, since they have lost their global market share of motor vehicles), resolve its energy crisis, raise productivity and improve its fiscal discipline, it is inevitable that the EUR will decline in value in the medium to longer term. In other words, a currency can be very strong today but become very weak tomorrow — even as the fundamental economics remain basically unchanged, when it is external factors that drive the exchange rates. We think the very huge liquidity in the currency markets facilitates such multi-finality outcomes.
Coming back to the ringgit, its strength has been even more impressive in the last three months. It gained 2.4% against the EUR, 1.5% against the USD, 4.5% on the GBP, 1.5% on the AUD, a huge 3.1% on the SGD, 7% on the JPY, 0.5% on the RMB, 5% on the Indonesian rupiah and 5.2% on the Philippine peso. This at a time when the USD strengthened substantially, too. It is a huge move for the ringgit — “Asia’s best-performing currency”. So, what are the reasons for this broad, sustained demand for the ringgit?
To summarise, the ringgit was strongest in 3Q2024 and 2Q2025, whereas gains were more gradual in 2Q2024, 3Q2025 and 4Q2025 (see Chart 1). For the two quarters in which the ringgit surged strongly, current accounts were in surplus but fell year on year. In fact, for 2Q2025, the current account surplus almost dropped to zero. In other words, based on the data, it is unlikely that the strength of the ringgit was driven by favourable trade dynamics.
This is also to be expected, as changes to current account do not swing unexpectedly, in any significant way, over a short time period (unless in times of crisis). Remember, exchange rates are driven by EXPECTATIONS, that is, they move more when the outcomes are less expected.
This is further reinforced by the fact that local deposits in foreign currencies continue to grow, that is, exporters are holding on to a larger share of their export earnings in foreign currencies (see Chart 2).
What is clear is the strong relationship between the ringgit and capital flows, primarily foreign portfolio flows and direct investments as well as funds held overseas by Malaysians. In the two quarters when the ringgit was strongest, there were also strong portfolio inflows. This is further evidenced by the significantly higher liquidity in the ringgit bond market (see Chart 3 next page). And in the quarters when the ringgit weakened, such as 4Q2024 and 1Q2025, there were massive portfolio outflows.
A possible additional factor for the recent strength in the ringgit is the anecdotal evidence of administrative measures to make it more difficult for Malaysians and local companies to remit transfers overseas. We stand ready to be corrected, since this impression is based only on public feedback. We know banks are asking for more documentation to approve fund transfers/payments.
Factor 1: Interest-rate differentials (monetary policy gap)
As the US Fed cuts its federal funds rate (and is expected to reduce further in the quarters ahead), the lower US rates relative to Malaysia (although the absolute difference in rates favours the US) can create an outflow from USD to ringgit. Currencies are financial assets whose value responds immediately to expected future yields.
Also, the narrower interest rate makes carry trades of emerging markets less attractive.
Past facts:
- In 2015: US tightening cycle, USD/MYR rose to 4.40;
- In 2021: US at zero interest rates, ringgit stabilises; and
- In 2024/25: The Fed cut rates, the ringgit strengthens.
Factor 2: Global risk sentiment
The USD is a safe-haven currency, and investors seek the USD during periods of risk-off (fear). These periods include episodes such as financial crises and pandemics. Emerging market currencies (including the ringgit) are pro-cyclical, which investors gravitate towards during periods of risk-on (growth).
This influences exchange rates in the short run, often overwhelming fundamentals.
Past facts:
- In 2009: A strong USD despite zero US interest rates;
- In 2020: Covid-19 pandemic, a strong USD, a weak ringgit at 4.40; and
- In 2024/25: Risk-on, capital flows to emerging markets, the ringgit strongest in Asia.
We think these two factors explain 70% to 80% of the recent strength of the ringgit. It is also clear they are driven by external factors.
Next week, we will discuss whether the current strength of the ringgit is sustainable. That is, are the medium- and longer-term drivers in place? For example, while the first factor, a rise in domestic interest rates relative to the US will typically cause the ringgit to appreciate immediately, owing to capital inflows, investors expect the currency to fall in the future. This is implied in the expected returns from uncovered interest parity. Also, can trade be sustained with the tariffs and fiscal sustainability be achieved with tempered reforms, or will our productivity ever catch up?
We will look at the long-term performance of the ringgit, what caused the rise and falls. The billion-ringgit question is this: If the strength of Asia’s strongest currency is the result of financial and economic fundamentals, why are stocks listed on Bursa Malaysia falling? The data says the year-to-date bond inflow into Malaysia is US$3.3 billion ($4.3 billion), but the ytd equity outflow is US$4.3 billion (although the timing of these two flows are not synchronised).
The Malaysian Portfolio gained 0.3% for the week ended Nov 26. United Plantations (+3.8%), LPI Capital (+1.2%) and Malayan Banking (+0.5%) were the three gaining stocks while Kim Loong Resources (-1.2%) and Hong Leong Industries (-2.1%) ended in the red. Total portfolio returns now stand at 195.4% since inception. This portfolio is outperforming the benchmark FBM KLCI, which is down 11.2% over the same period, by a long, long way.
The Absolute Returns Portfolio, on the other hand, fell 0.3%, paring total returns to 41.3% since inception. The top three gainers were Kanzhun (+4.8%), SPDR Gold MiniShares (+2.1%) and Berkshire Hathaway (+2.0%). Trip.com Group (-6.2%), Ping An Insurance – H (-1.3%) and Alibaba Group Holding (-0.8%) were the notable losers last week. Given the rising short-term risks in the US and global markets and the fact that we have far exceeded our target annual return for this portfolio, we have taken the prudent stance to raise more cash. We disposed of all our remaining shares in JPMorgan Chase, Goldman Sachs and CrowdStrike, as well as Tencent Holdings. All made excellent returns for our holding periods. Following these disposals, cash holdings now stand at almost 38% of total portfolio value.
Meanwhile, the AI portfolio was down 0.4% last week. Total portfolio returns now stand at 1.7% since inception. The top gainers were Marvell Technology (+7.9%), Twilio (+5.7%) and Amazon.com (+2.9%). Datadog (-10.2%), RoboSense (-3.2%) and ServiceNow (-1.7%) were the biggest losers for the week.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports
