Cross Currency Pairs

Cross Currency Pairs (also known as 'currency crosses' or simply 'crosses') are pairs in the foreign exchange (or forex) market that do not involve the US Dollar (USD). In the world of currencies, the USD is the king, acting as the global reserve currency. Historically, if you wanted to exchange, say, British Pounds for Japanese Yen, the transaction would happen in two steps: Pounds to US Dollars, then US Dollars to Yen. Cross currency pairs cut out the middleman. They allow for the direct exchange between two non-USD currencies, such as the Euro and the British Pound (EUR/GBP), the Euro and the Japanese Yen (EUR/JPY), or the Australian Dollar and the Canadian Dollar (AUD/CAD). This direct pricing offers a cleaner view of the economic relationship between two countries or currency zones, without the powerful, and sometimes distorting, influence of the USD.

Every currency pair has a base currency (the first one listed) and a quote currency (the second). For the pair EUR/GBP, the Euro is the base, and the Pound is the quote. If the price is 0.85, it means you need 0.85 British Pounds to buy 1 Euro. Interestingly, while you can trade these pairs directly, their “true” value is often still derived from their individual pairings with the US Dollar. The market uses a simple calculation to create the cross rate.

• Example: To find the exchange rate for the Euro vs. the Japanese Yen (EUR/JPY), the market looks at the rates for EUR/USD and USD/JPY. The formula is:
• EUR/JPY = EUR/USD x USD/JPY

This behind-the-scenes calculation ensures all currency rates are logically interconnected. For the investor, however, the important part is the final, directly tradable rate that reflects the relative strength of the two non-US economies.

At first glance, forex trading might seem like the opposite of patient, long-term value investing. However, understanding cross currency pairs offers valuable insights.

Crosses can give you a clearer signal about the relative health of two economies. For example, if you are considering investing in an Australian company that exports heavily to New Zealand, the movement of the AUD/NZD pair is critical. Its performance, stripped of direct US economic noise, tells you how the market perceives the relative strength of Australia versus New Zealand. This is a powerful tool for macroeconomic analysis when assessing international investments.

Value investors often seek opportunities abroad. If you, as a US-based investor, own shares in a top-tier German company, your returns are affected by two things: the company's stock performance and the EUR/USD exchange rate. But what if that German company does most of its business in Switzerland? The EUR/CHF cross becomes a crucial factor. Understanding it can help you anticipate how currency fluctuations might impact the company's earnings. For sophisticated investors, it also opens the door to hedge specific currency risks affecting their portfolio.

While there are many crosses, a few “majors” are widely watched and offer broad economic clues.

• EUR/GBP: This is the ultimate gauge of the economic relationship between the Eurozone and the United Kingdom. It is highly sensitive to trade negotiations, interest rate decisions from the European Central Bank and the Bank of England, and political events like Brexit.
• EUR/JPY: Often viewed as a global risk indicator. The Japanese Yen is considered a traditional safe-haven currency. During times of global uncertainty, investors tend to sell riskier assets (and the currencies associated with them, like the Euro) and flee to the perceived safety of the Yen. A falling EUR/JPY can therefore signal rising fear in the market.
• GBP/JPY: Nicknamed “The Dragon” or “The Widow-Maker” for its extreme volatility. Because both currencies can move significantly, this pair often experiences wild swings. For a value investor, it's a stark reminder of how currency risk can amplify or destroy investment returns if not properly understood.

The key for a value investor is to use currency crosses as an analytical tool, not a speculative one.

• Complexity: Analyzing two economies simultaneously, plus their interaction, is inherently complex.
• Focus on the Business: The primary focus must always remain on the intrinsic value of the underlying business you are investing in. Currency movements are an external factor that can affect value, but they are not the source of it.
• Avoid Speculation: Leave the high-frequency trading of volatile pairs like GBP/JPY to the speculators. A value investor's goal is not to predict short-term currency swings.

The real takeaway is this: A globally-minded value investor should watch cross currency pairs to better understand the economic landscape in which their international companies operate. They are another piece of the puzzle, helping you to make more informed decisions and to better appreciate the risks and opportunities of investing beyond your home border.