JPMorgan Chase’s Foreign Exchange Forecasting Accuracy

A case study in evaluating an individual institution’sforeign exchange forecasting accuracy

• Veselina (Vesi) Dinova – Had been asked by her director at Teknekron (US) to review the exchange rate forecasting

accuracy of her company’s primary financial services provider, JPMorgan Chase (JPMC).

– Vesi had focused on the three primary currencies the company’s operations revolved around , the dollar, the euro, and the yen

– Teknekron had relied upon JPMC for most of its currency advisory services for years, and the forecasts provided by JPMC were regularly used in sales and sourcing decisions – including pricing

– The rise of the euro against the dollar in recent years had, however, raised the interest in the accuracy of these forecasts.

• US dollar/euro spot exchange rate– Vesi plotted the forecasts provided by JPMC and the actual spot exchange rate for the

2002-2005 period, in 90-day increments

– As illustrated by Exhibit 1, the results were not encouraging. Although JPMC had hit the actual spot rate dead-on in both May and November 2002, the size of the forecasting errors, and direction of movement, seemed to increase over time

JP Morgan’s FX Forecasting

Exhibit 1 Monthly Average Exchange Rates: US$/€

• Growing Tension Over Accuracy– What was most worrisome to Vesi was that in a good part of 2004, JPMC was getting the

direction wrong. In February 2004 they had forecast the spot rate to move from the current rate of $1.27/€ to $1.32/€, but in fact the dollar had appreciated dramatically in the following three month period to close at $1.19/€.

– Although Teknekron used a weighted moving average of the actual spot and forecasted rate in its foreign currency pricing (in this case, in euros), the directional error had caused the firm to average in a much weaker dollar than what had happened

– The buyer had been irritated

• Teknekron’s Exposure– Whereas Teknekron did most of its sales in North America and Europe (hence the euro-

based pricing), its sourcing was confined to the United States and Japan

– Teknekron’s Japanese suppliers provided 3% discounts for Japanese yen-denominated invoicing, which Teknekron had traditionally been happy to take (the discount) and provide (yen payments)

– But this required Vesi’s company to manage and control its cost of goods sold – including the yen-denominated costs

JP Morgan’s FX Forecasting

• Japanese yen/US dollar spot rate– Vesi now turned to the predicted accuracy of JPMC on the yen

– Exhibit 2 provides an overview of that analysis

– Once again, although the dollar was consistently falling against the yen, the forecasting accuracy – at least by eyeballing the graphic, was not encouraging.

– The most recent quarter had closed at ¥108/$, although the forecast had been to follow trend to ¥96/$.

JP Morgan’s FX Forecasting

Exhibit 2 Monthly Average Exchange Rates: Japanese Yen per U.S. Dollar

1. How would you actually go about calculating the statistical accuracy of these forecasts? Would Vesi have been better off using the current spot rate as the forecast of the future spot rate, 90 days out?

2. Forecasting the future is obviously a daunting challenge. All things considered, how well do you think JPMC is doing?

3. If you were Vesi, what would you conclude about the relative accuracy of JPMC’s spot rate forecasts?

JP Morgan’s FX Forecasting: Case Questions