US Macro Announcements and the Euro/Dollar Exchange Rate MSc Student: Simona A. Popa Supervisor : Professor Moisa Altar, PhD Bucharest, 2007 1. Purpose of the paper:
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Simona A. Popa
ProfessorMoisa Altar, PhD
It was proved that news about US economy have a greater impact on EUR/USD exchange rate than that of euro zone news. The explanations for this fact are the followings:
where et is the daily exchange rate EUR/USD, Δ (ln et) represents the first difference in logarithm of the daily exchange rate EUR/USD, Δ (ln et) = ln et - ln et-1 and Sk,t is the standardized news for the macroeconomic announcement k (k = 1,…,16) at the time t, and the forecasts are based only on those observations (Δ (ln et ), Sk,t) for which an announcement was made at the time t. In this paper, we used the first difference of the daily logarithm of EUR/USD exchange rate in order to show the variation of the profitability.
Results (see Table 1):
- there has been found five announcements statistically significant;
- the econometric results of these variables have the greatest R2 values;
- the signs of the regression coefficients of these variables are in line with the economic intuition.
Employment news can greatly influence the dollar’s value in currency markets.
A vigorous jobs report - drive interest rates higher - makes the dollar more attractive to foreign investors - earn more interest income by owning US Treasury securities.
An anemic jobs report softens demand for US currency - it spells trouble for American stocks and puts downward pressure on rates - making the dollar less appealing for foreigners.
A depressed consumer makes foreign investors with exposure in the US markets a bit nervous - raises the prospects of falling interest rates and a weakening business climate. Foreign investors might sell the US currency in search for higher yields and a stronger economy elsewhere.
An upbeat consumer can lift US interest rates and stock market returns to levels that promise a higher return relative to other regions in the world and this normally has the effect of increasing demand for dollars.
To foreign investors, a strong American economy is viewed more favorably than a weak one. Robust economic activity in the US motivates corporate profits and firms interest rates; foreign investors see opportunities to make money in the stock market and from higher-yielding Treasury bills and bonds. All this will increase the demand for dollars. If the Federal Reserve moves quickly to preempt inflation by driving up short term rates, odds are it would also lead to an appreciation of the dollar because of the perception that the US central bank is ahead of the curve in containing price pressures. However, if inflation acceleates and stays at a high level, it would lower US competitiveness in the world and worsen the country’s foreign trade deficit, a scenario that can make US currency far less appealing.
If the economy is fundamentally healthy and inflation is in check, the dollar will likely bounce higher with a Purchasing Managers Index above 50. Conversely, should the ISM report portray a manufacturing sector moving unsteady on recession, foreigners might sell some of their dollar linked investments, depressing the dollar’s value against other key currencies.
While investors in the bond and stock markets agonize over how to respond to the latest international trade figures, currency traders take a more direct approach. Unless caused by a deep recession in the US, any improvement in the trade balance is viewed favorably for the dollar. The more goods and services foreigners buy from the US, the more dollars they will need to pay for these American products. In contrast, a worsening trade deficit can undermine the dollar. To purchase foreign goods and services, Americans have to sell dollars so they can pay for these products in local currencies. The problem is that foreign exchange traders are already swimming in a sea of surplus dollars. Flooding the market with even more dollars can only further depress the dollar’s value.
Results (see table below):
- this model has the same statistically significant variables as those of the before mentioned two-variables regression model 1, with the same correct sign of the regression coefficients. The single difference from the results of two-variable regression models is the lower significance level of advance GDP and trade balance.
- the model’s coefficient of determination has a small value for an econometric model (R2 = 0.046282) but this result is in line with results obtained by other empirical models which try to explain the exchange rates’ movements.
- the signs of the regression coefficients are in line with economic intuition.
The reason for using model (2’) is based on the results obtained by Andersen, Bollerslev, Diebold and Vega (2002) who consider that the the most part of the explanatory power of the model for conditional mean comes from the laged dependent variables and from the current values of the announcements and Ehrmann and Fratzscher (2004) consider the fact that in 99% of the cases one lag for the exchange rate variation is sufficient.
To evaluate, the US indicators were grouped into six types: real activity, consumption, investment, prices, trade balance and forward-looking. GDP was kept separately. Within each group the announcements were arranged in the chronological order of the release time. (as in table 1)
Based on the results of the two-variable regression model it was verified if within the same category of macroeconomic indicators, news released earlier tend to have a greater impact than that of the later released news.