Different maturities of currency forwards reflect more than a simple interest rate differential. Markets price forward points to capture expectations about future spot rates, the cost of carry, and the term structure of risk and liquidity. Those forces change with maturity, so a one-month forward can be priced very differently from a one-year forward.
Drivers of maturity-dependent forward points
At the foundation is covered interest parity, which links forward points to short-term interest rate differentials between two currencies. When markets are frictionless this relationship pins forward pricing. In practice, deviations arise because of funding and credit frictions, a point emphasized in research by Robert N. McCauley Bank for International Settlements and by Hyun Song Shin Bank for International Settlements who document how global banks’ balance sheets and repo market conditions alter forward pricing across horizons. Longer maturities embed a larger cumulative impact of these frictions and therefore a different premium than short maturities.
Market structure and risk premia
Liquidity and volatility matter. Short-dated forwards are influenced heavily by overnight and near-term funding pressures and seasonal flows such as trade settlement or tax payments. Longer-dated forwards incorporate a term premium for uncertainty about future monetary policy, macro shocks, and counterparty credit risk. Cross-currency basis spreads in the FX swap market, regularly analyzed by the Bank for International Settlements, widen or invert differently across maturities when demand for specific currency funding is concentrated in certain tenors. Emerging market supply and capital control nuances can accentuate these term patterns, making long-dated hedges markedly more expensive for local firms than for global players.
Consequences for economies and firms
Differential pricing across maturities affects corporate hedging choice and sovereign borrowing costs. Exporters and importers choose tenors to match cash flows; when long-dated forward points carry higher premia, firms may remain exposed or accept more expensive hedges, raising earnings volatility. For countries, persistent cross-maturity distortions can signal funding stress and amplify currency mismatch risk, a concern highlighted in analyses by the International Monetary Fund. Central banks’ interventions and liquidity-provision operations can compress term premia but may do so unevenly across maturities, with implications for inflation pass-through and financial stability.
Understanding why forward points vary by maturity thus requires looking beyond interest differentials to market microstructure, bank funding, and policy and territorial factors that shape demand and supply at each tenor.