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We propose an exchange rate model which is a hybrid of the conventional specification with monetary fundamentals and the Evans-Lyons microstructure approach. We argue that the failure of the monetary model is principally due to private preference shocks which render the demand for money unstable. These shocks to liquidity preference are revealed through order flow. We estimate a model augmented with order flow variables, using a unique data set: almost 100 monthly observations on inter-dealer order flow on dollar/euro and dollar/yen. The augmented macroeconomic, or “hybrid”, model exhibits greater in-sample stability and out of sample forecasting improvement vis a vis the basic macroeconomic and random walk specifications. JEL classification: D82; E41; F31; F4