Currency Peg Explained: Fixed vs Floating Exchange Rates and Why It Matters for Traders
Macro Guide, 2026
By Ken Chigbo, Founder, KenMacro, UK macro desk.
Updated 2026-06-03
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The short answer
A currency peg is a policy under which a country fixes the value of its currency to another currency, usually the US dollar or the euro, and commits to defending that fixed rate. The opposite is a floating exchange rate, where the currency’s value is set freely by supply and demand in the market with no official target. Most of the world’s major currencies, the dollar, euro, pound, yen, Australian dollar, float freely. Pegs are common among smaller, trade-dependent or commodity economies that want exchange-rate stability: the Hong Kong dollar is pegged to the US dollar, the Saudi riyal and most Gulf currencies are pegged to the dollar, and the Danish krone is pegged to the euro. In between sit managed floats, where the currency mostly floats but the central bank intervenes to smooth or steer it, as China does with the yuan. The trade-off is governed by the impossible trinity: a country cannot simultaneously have a fixed exchange rate, free movement of capital, and an independent monetary policy; it can pick only two. For traders, a credible peg makes the currency boring and one-sided most of the time, but the rare moment a peg breaks produces some of the most violent and profitable moves in all of macro, because the rate that was pinned for years reprices in hours.
How a peg works and the spectrum of regimes
Exchange-rate regimes sit on a spectrum from hard fix to free float. At one end, a currency peg fixes the exchange rate to an anchor currency and the central bank commits to maintaining it by buying or selling its own currency in the market and by aligning its interest rates with the anchor. The most rigid version is a currency board, like Hong Kong’s, where every unit of local currency in circulation is fully backed by reserves of the anchor currency, leaving almost no discretion. At the other end, a free float, used by the dollar, euro, pound and yen, lets the market set the rate with no official target, and the central bank focuses its policy on domestic goals like inflation rather than the exchange rate. In the middle sits the managed float or dirty float, where the currency broadly floats but the central bank intervenes to smooth volatility or nudge the rate, which is how China runs the yuan within a daily band. The choice is not cosmetic: it determines whether a country imports its monetary policy from the anchor or sets its own, and it shapes how the currency trades.
The impossible trinity, the rule that governs every peg
The single most important concept for understanding pegs is the impossible trinity, also called the trilemma. It states that a country can have at most two of these three things at once: a fixed exchange rate, free movement of capital across its borders, and an independent monetary policy. It cannot have all three. The logic is clean. If you peg your currency and allow capital to flow freely, then to defend the peg your interest rates must track the anchor country’s rates, because if they diverge, capital floods in or out chasing the rate difference and breaks the peg. So you have given up independent monetary policy. If you instead want to set your own rates and keep free capital flows, you must let the currency float. If you want both a fixed rate and your own monetary policy, you must restrict capital movement, which is the route China has historically taken. Every peg in the world is a choice within this trilemma, and most peg breaks happen precisely when a country tries to cheat it, defending a fixed rate while running a monetary policy the market does not believe is sustainable.
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How pegs break, and why the break is the trade
A peg is a promise, and promises are only as good as the reserves and credibility behind them. A peg comes under attack when the market believes the fixed rate is no longer justified by fundamentals, typically because the country is running an inflation or deficit problem that its pegged monetary policy cannot address. Speculators sell the currency, the central bank must buy it with its foreign-exchange reserves to hold the line, and if the pressure persists the reserves drain until the central bank can no longer defend the rate and is forced to abandon it. When that happens the currency, which was pinned for years, reprices violently in hours or days to where the market thinks it should be. The history is littered with these: the British pound’s ejection from the European Exchange Rate Mechanism in 1992, when speculators forced the Bank of England to abandon its peg in a single day; the collapse of the Thai baht peg in 1997 that triggered the Asian financial crisis; and the Swiss National Bank’s shock abandonment of its euro cap in January 2015, which moved the franc by nearly 30 percent in minutes and blew up brokers and funds. The lesson is brutal and consistent: a pegged currency is a coiled spring, calm until it snaps.
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How the desk thinks about pegged and floating currencies
Three rules. First, know which regime you are trading, because it dictates the currency’s behaviour. A floating major moves continuously on rate differentials, risk sentiment and flows, and is what most retail traders trade. A hard-pegged currency barely moves day to day, which makes it a poor instrument for ordinary trend trading but a potential source of an enormous asymmetric move if the peg is under strain. Second, for pegged currencies, watch the fundamentals that pressure the peg: the country’s foreign-exchange reserves, its inflation and deficit relative to the anchor, and whether its interest rates are credibly aligned with the anchor’s. A peg defended by draining reserves is living on borrowed time. Third, respect the tail risk of a managed float like the yuan, where the central bank can shift the band or let the currency move suddenly for policy reasons, producing gaps that wreck unhedged positions. The Bretton Woods and central-bank-intervention pieces linked below cover the historical fixed-rate system and the mechanics of how central banks defend a currency.
The desk’s checklist
- Place the currency on the spectrum. Hard fix and currency board at one end, free float at the other, managed float in the middle. The regime dictates behaviour: floats move continuously, hard pegs barely move until they snap, managed floats can gap on policy decisions.
- Apply the impossible trinity. A country can have only two of: a fixed exchange rate, free capital movement, and independent monetary policy. Most peg breaks happen when a country tries to cheat the trilemma, defending a fixed rate with a policy the market does not believe.
- Watch the reserves on a pegged currency. A central bank defends a peg by buying its own currency with foreign-exchange reserves. Draining reserves to hold a rate the fundamentals do not support is the clearest sign a peg is living on borrowed time.
- Respect the asymmetric break. A pegged currency is calm for years then reprices violently when the peg snaps, as the pound in 1992, the baht in 1997 and the Swiss franc in 2015 all showed. The break is the trade, but it is rare and dangerous to time.
- Mind the gap risk on managed floats. A managed float like the yuan can shift its band or move suddenly for policy reasons, producing gaps that wreck unhedged positions. Size and stop accordingly, and never assume a managed currency will keep behaving as it has.
Frequently asked
What is a currency peg?
A currency peg is a policy under which a country fixes the value of its currency to an anchor currency, usually the US dollar or the euro, and commits to defending that fixed rate by buying or selling its own currency and aligning its interest rates with the anchor. Examples include the Hong Kong dollar and the Saudi riyal, both pegged to the US dollar, and the Danish krone, pegged to the euro.
What is the difference between a fixed and a floating exchange rate?
A fixed or pegged exchange rate is held at a set value against an anchor currency by the central bank. A floating exchange rate is set freely by supply and demand in the market with no official target, which is how the dollar, euro, pound and yen trade. In between sits a managed float, where the currency broadly floats but the central bank intervenes to steer it, as China does with the yuan.
What is the impossible trinity?
The impossible trinity, or trilemma, states that a country can have at most two of three things at once: a fixed exchange rate, free movement of capital, and an independent monetary policy. It cannot have all three. If you peg and allow free capital flows, your interest rates must track the anchor, so you give up independent policy. Most peg breaks happen when a country tries to defy this rule.
Why do currency pegs break?
A peg breaks when the market believes the fixed rate is no longer justified by the country’s fundamentals, usually an inflation or deficit problem. Speculators sell the currency, the central bank defends it by spending foreign-exchange reserves, and if the pressure persists the reserves drain until the bank can no longer hold the rate and abandons it. The currency then reprices violently, as the British pound did in 1992 and the Swiss franc in 2015.
Which currencies are pegged and which float?
Most major currencies float freely: the US dollar, euro, British pound, Japanese yen and Australian dollar. Pegged currencies are common among smaller or trade-dependent economies: the Hong Kong dollar and most Gulf currencies including the Saudi riyal are pegged to the US dollar, and the Danish krone is pegged to the euro. The Chinese yuan runs as a managed float within a daily band.
Floating majors are where the desk trades the rate differentials and flows every day, and a peg break is the rare asymmetric move. To trade FX cleanly you need tight pricing and reliable execution. The desk’s broker stack:
Which broker for this
You cannot trade any of this without a broker that fits how you actually trade. The desk’s stack, by what you need most.
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Related from the desk
Sources and further reading
Educational analysis only, not financial advice. KenMacro has commercial partnerships with some firms referenced and may earn a commission if you open an account, at no cost to you. Manage risk against your own circumstances.
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