Abstract
We show that shifts in demand between domestic and foreign goods are a central driver of exchange rate dynamics. In a framework with costly international financial intermediation, trade rebalancing shocks——arising from tariffs, transport costs, or preferences——account for roughly half of real exchange rate fluctuations. Exogenous deviations from uncovered interest parity explain only a smaller share. Incorporating trade flow data into the analysis allows us to link exchange rate movements more closely to macroeconomic fundamentals and to provide a unified explanation for classic exchange rate puzzles as well as the co-movement of exchange rates with the trade balance.