This paper uncovers a novel component for exchange rate predictability based
on the price difference between sovereign credit default swaps denominated in
different currencies. This new forecasting variable – the credit-implied risk premium – captures the expected currency depreciation conditional on a severe
but rare credit event. Using data for 16 Eurozone countries, we find that the
credit-implied risk premium positively forecasts the dollar-euro exchange rate
return at various horizons. Moreover, a currency strategy that exploits the informative content of our predictor generates substantial out-of-sample economic
value against the na¨ıve random walk benchmark.