Fixed Exchange Rate forex Guide: Trading Pegs & De-pegging Risks 2025

What is a Fixed Rate？

A fixed exchange rate is when a country ties its currency value to another currency. This system is different from a floating exchange rate, where market forces determine a currency's value.

In this guide, we'll cover everything you need to know about fixed exchange rates in the forex market. We'll explain how they work, what happens when they break, and how to trade them effectively.

How a Fixed System Works

The fixed exchange rate system depends on a country's central bank. It sets up and defends the currency peg.

The Central Bank's Role

The central bank acts as a big buyer and seller in the forex market. It stands ready to trade its currency at the set price to keep things stable.

This constant presence makes the peg believable to international markets and traders.

Maintaining the Peg: Intervention

To keep the exchange rate steady, the central bank must step in when needed. This requires careful balance.

• Setting the Par Value: The government first announces the official pegged rate. For example, the Saudi Riyal is pegged at about 3.75 riyals to 1 U.S. dollar. This becomes the target price.

• Defending Against Weakness: If market forces push the currency below the peg, the central bank steps in. It buys its own currency using its foreign reserves. This increases demand and pushes the price back up.

• Curbing Excess Strength: If the currency rises above the peg, the central bank does the opposite. It sells its own currency to increase supply and buys foreign currency. This brings the price back down to the target.

The Role of Foreign Reserves

A large pool of foreign reserves gives a central bank the power to defend its peg. Without enough reserves, the promise to maintain a fixed rate is empty.

These reserves, usually held in dollars or euros, allow the central bank to buy its own currency when needed. Countries like China and Saudi Arabia have some of the world's largest foreign reserves. This shows their commitment to their currency policy.

Fixed vs. Floating Rates

Choosing between fixed and floating exchange rates is a major economic decision. This choice affects a country's economy and how its currency behaves.

Key Differences at a Glance

Feature	Fixed Exchange Rate	Floating Exchange Rate
Value Determination	Set by Government / Central Bank	Determined by Market Supply & Demand
Volatility	Very Low / Stable	Can be High / Fluctuates freely
Certainty for Business	High (predictable costs & revenues)	Low (currency risk must be managed)
Central Bank Intervention	Constant and Necessary	Infrequent / Optional (e.g., to smooth volatility)
Monetary Policy Autonomy	Limited (must support the peg)	Independent (can set interest rates freely)
Vulnerability	Prone to speculative attacks	Adjusts automatically to economic shocks

Pros and Cons of a Peg

Using a fixed exchange rate means trading stability for flexibility. This choice comes with clear benefits and serious risks.

Advantages: The Allure of Stability

The main benefits of a pegged currency create a stable and predictable environment.

• Certainty and Reduced Risk: This helps international trade and investment. Companies can predict costs and revenues without worrying about currency swings.

• Inflation Control: A country with high inflation can "borrow" the discipline of a stable currency like the U.S. dollar. By pegging to it, the country follows the anchor country's monetary policy, which can help control prices.

• Promotion of Trade: Steady exchange rates make cross-border business easier. They remove a major unknown from business planning, making a country more attractive for trade and investment.

Disadvantages: The Hidden Costs

The stability of a peg comes at a high price and can create significant risks.

• Loss of Monetary Autonomy: This is the biggest drawback. A central bank with a pegged currency can't freely use interest rates to manage its economy. If the country faces a downturn, it might want to lower rates to boost growth. But if this would weaken the currency and threaten the peg, the central bank can't do it.

• Vulnerability to Speculative Attacks: If traders believe a peg is overvalued, they might attack it. They do this by selling the pegged currency in large amounts, betting that the central bank will run out of reserves and have to devalue.

• Potential for Violent Shocks: While a pegged currency is usually stable, its failure is rarely gradual. When a peg breaks, it typically happens suddenly and violently. The built-up pressure releases all at once, causing sharp currency moves that can lead to huge losses.

A Trader's Guide to Pegs

For forex traders, a pegged currency creates a unique market with specific opportunities and risks. Knowing how to navigate it shows trading skill.

Trading Opportunities

The stability of a pegged currency can be used strategically, if you respect the risks.

One common strategy is the carry trade. This involves borrowing in a low-interest currency (like the Japanese Yen) and investing in a pegged currency with higher interest rates. The goal is to profit from the interest difference, while the peg reduces exchange rate risk.

Also, pegged currencies often trade in tight ranges. This allows for range-bound strategies, buying at the low end and selling at the high end, assuming the central bank will defend these levels.

The Ultimate Risk: De-Pegging

The daily stability of a pegged currency can be misleading. The real risk—one that can wipe out an account overnight—is when the peg fails.

This is a rare but devastating event in forex. It happens when a central bank can no longer defend its currency's fixed value. The market move that follows is usually explosive.

Spotting a Vulnerable Peg

To survive or even profit from a de-pegging event, you need to watch for warning signs that a peg is under stress.

• Dwindling Foreign Reserves: This is the clearest signal. Is the central bank running low on ammunition to defend the peg？ Official data releases are public and should be watched closely. A steady decline in reserves is a warning sign.

• Diverging Economic Fundamentals: A peg becomes strained when the pegged country's economy moves opposite to the anchor country's. For example, if the pegged country has high inflation and recession while the anchor country is stable, pressure to adjust the exchange rate will grow.

• Political Pressure and Instability: Listen to political talk. Are leaders starting to question the peg？ Talk about the peg being "unfair" to exporters or "harmful" to the local economy may signal a shift in political will.

• Surging Black Market Rates: In countries with currency controls, a growing gap between the official rate and the street rate shows pressure. It reveals that the official rate no longer reflects the true value of the currency.

• Rising Costs of Insurance: The derivatives market offers clues. Rising prices for currency options or credit default swaps on a country's debt show that the market sees higher risk of devaluation.

Real-World Examples & Case Study

Seeing fixed exchange rates in action helps understand these concepts better.

Current Peg Examples

Several major currencies today use a fixed exchange rate system.

• Hard Peg to USD: The Saudi Riyal (SAR) is pegged at about 3.75 to the U.S. dollar. The United Arab Emirates Dirham (AED) is pegged at about 3.67. The Hong Kong Dollar (HKD) is pegged to the USD around 7.80.

• Managed/Hybrid Systems: The Chinese Yuan (CNY) uses a "crawling peg" or "managed float." It's not strictly fixed but is heavily controlled by China's central bank, which sets a daily reference rate and allows limited movement around it.

Anatomy of a Peg Break: The 2015 Swiss Franc Shock

The most dramatic recent peg break was when the Swiss National Bank (SNB) abandoned its cap on the Swiss Franc.

The Setup (2011): During the Eurozone debt crisis, investors rushed to the Swiss Franc as a safe haven. This made the franc rise sharply, hurting Swiss exports and risking deflation. In September 2011, the SNB set a minimum exchange rate of 1.20 francs per euro.

The Mounting Pressure (2012-2014): To defend this peg, the SNB had to create new francs to buy euros. This caused the SNB's balance sheet and foreign reserves to grow enormously, approaching the size of Switzerland's entire GDP. The cost of maintaining the peg became too high.

The Break (January 15, 2015): In a shocking move, the SNB suddenly announced it was ending the minimum exchange rate. There was no warning.

The Aftermath: The market reaction was instant and violent. The EUR/CHF rate collapsed. In minutes, the franc surged nearly 30% against the euro, with the rate dropping from about 1.20 to below 1.00. The extreme move bankrupted many traders, hedge funds, and even some forex brokers who were caught on the wrong side.

The Unforgettable Lesson: The 2015 CHF event shows the huge hidden risk in fixed exchange rate systems. It proved that stability can vanish instantly, and that a central bank's word only lasts until it doesn't.

Conclusion: Enduring Relevance

The world of fixed exchange rates features long periods of calm broken by moments of explosive change.

Key Takeaways

The core trade-off of a fixed exchange rate is between stability and flexibility. This choice shapes a nation's economy and the trading environment.

For forex traders, a pegged currency offers both opportunity and danger. It allows for steady strategies like the carry trade, but always carries the hidden risk of a sudden de-pegging event.

Understanding fixed exchange rates isn't just academic. It's essential for risk management for any serious forex trader.