The high-frequency response of exchange rates and interest rates to macroeconomic announcements

Abstract

The joint movements of exchange rates and U.S. and foreign term structures over short-time windows around macro announcements are studied using a 14-year span of high-frequency data. In order to evaluate whether the joint effects can be reconciled with conventional theory, the implications of these joint movements for changes in expected future exchange rates and changes in foreign exchange risk premia are deduced. For several real macro announcements, a stronger than expected release appreciates the dollar today, and must either (i) lower the risk premium for holding foreign currency rather than dollars, or (ii) imply net expected dollar depreciation over the ensuing decade. Abstract: Many recent papers have studied movements in stock, bond, and currency prices over short windows of time around macro announcements. This paper adds to the announcement effects literature in two ways. First, we study the joint announcement effects across a broad range of assets--exchange rates and U.S. and foreign term structures. In order to evaluate whether the joint effects can be reconciled with conventional theory, we interpret the joint movements in light of uncovered interest rate parity or changes in risk premia. For several real macro announcements, we find that a stronger than expected release appreciates the dollar today, but that it must either (i) lower the relative risk premium for holding foreign currency rather than dollars, or (ii) imply considerable future expected dollar depreciation. The latter implies an overshooting behavior akin to that described by Dornbusch (1976). Second, we use a longer span of high frequency data than has been common in announcement work. A longer span of high frequency data contributes to the precision of our estimates and allows us to explore the possibility that the effects of macro surprises on asset prices have varied over time. We find evidence, for example, that PPI releases had a larger effect on U.S. interest rates before about 1992 than subsequently.

Unconventional monetary policy had large international effects

“…20 These target coefficients are roughly comparable to those in the literature, though the estimates are somewhat sensitive to the frequency of the exchange rate changes and the inclusion of a few very surprising intermeeting target rate changes (see Faust et al, 2007;Neely and Dey, 2010 policy effect on exchange rates during the event windows, we will use 12-month-ahead eurodollar futures changes as the path shock but we will replace the federal funds surprise in (15) with four times the observed U.S. long-rate changes during the event windows. The lower panels of Table 5 display the results of this rule-ofthumb prediction exercise.…”

Does FOMC news increase global FX trading?

“…Abnormal FX trading, particularly for the USD, is observed with a lag following the FOMC meeting and has a duration of two business days. This duration is longer than FX price responses to FOMC news, see Ahn and Melvin (2007), Andersen et al (2003), Bonser-Neal et al (1998), Faust et al (2006), and Hausman and Wongswan (2006). The lagged response in FX volume is consistent with 2-day settlement in the FX spot market.…”

“…Previous empirical research has focused on the price response to FOMC news. Ahn and Melvin (2007), Andersen et al (2003), Faust et al (2006), and Hausman and Wongswan (2006) show that foreign exchange (FX) quotes respond in a matter of minutes to public information (news) released by the FOMC. 1 Despite the vast empirical evidence on FX price responses to monetary policy shocks, little is known as to how global currency volume behaves in the face of FOMC days.…”

The high-frequency response of exchange rates to monetary policy actions and statements

“…1 Two recent contributions examine the impact of the US Federal Reserve's monetary policy on asset prices as I do in this study. Faust et al (2007) use intraday data to examine the response of exchange rates to scheduled macroeconomic announcements and Fed decisions. 2 The present paper shares the finding that public news has a significant impact both on the level and volatility of asset prices in the aftermath of announcements, and goes one step further by showing that the surprise component of FOMC statements, as opposed to the surprise component of its policy decisions, greatly adds to our understanding of the response of exchange rates to monetary policy announcements.…”