The Influence of Fundamentals on Exchange Rates: Findings From Analyses of News Effects

Abstract

As we survey the literature of macroeconomic news in the foreign exchange market, we can by now look back on nearly 30 years of research. The first studies which analysed news effects on exchange rates were established in the early 1990s (see, for example, Dornbusch). Almost at the same time Meese and Rogoff published their influential paper, revealing the forecasting inferiority in exchange rates of structural models against the random walk. This finding has shocked the pillars of exchange rate economics and thus cast general suspicion on research focusing on fundamentals in this field. The eventual rising popularity of event studies can partly be attributed to the re-establishment of the raison d'être of exchange rate economics. This work focuses on systematically surveying this literature with particular respect to its primary goal, i.e. shedding light on the analytical value of fundamental research. Thus, its major findings are, first, fundamental news does matter, whereas non-fundamental news matters to a lesser degree. Second, news influences exchange rates via two separated channels, i.e. incorporating common information into prices directly or indirectly based upon order flow. Third, with a few exceptions the impact of fundamental news on exchange rates is fairly stable over time.

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“…The issue of dependence between exchange rates has been extensively described in the literature. Rebitzky (2010) analysed articles on this subject written from 1990, so over 30 years, and according to his findings, most researchers agree that momentous news has a significant influence on exchange rates. Yet, some other researchers show that there are exceptions - Engel & West (2005), for example, demonstrate that fundamentals (such as relative money supplies, outputs, inflation and interest rates) do not necessarily improve floating exchange rate forecasts, while the opposite relationships hold.…”

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“…This correlation may be seen during both expansions and recessions; however, it is more pronounced during global recessions and periods of significant depreciation and appreciation. On the fundamental influence of news on exchange rates, Rebitzky (2010) discovers that fundamental news matters more than non-fundamental news. Fundamental news are those that are directly related to announcement that borders on macroeconomic fundamentals that affect exchange rate behavior, by analyzing the impact of interest rate, inflation rate on the relative value of a currency through identifying the primary drivers of a currency's intrinsic value, forex participants are then able to craft informed trading decisions.…”

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“…On the other hand, the econometric works of K. Iwatsubo, I. W. Marsh [19], R. Rebitzky [20], S. Heiden, C. Klein, B. Zwergel [21] emphasize the influence of expectations or the appearance of fundamental data on the dynamics of exchange rates.…”