Monetary Policy and Currency Returns: The Foresight Saga

47 Pages Posted: 9 Jun 2017 Last revised: 27 Oct 2017

Dmitry Borisenko

University of St. Gallen

Igor Pozdeev

New York University Stern School of Business; University of Saint Gallen, School of Finance

Date Written: October 24, 2017

Abstract

We document a drift in exchange rates before monetary policy changes across major economies. Currencies tend to depreciate by 0.7 percent over ten days before policy rate cuts and appreciate by 0.5 percent before policy rate increases. We show that available fixed income instruments allow to accurately forecast monetary policy decisions and thus that the drift is foreseeable and exploitable by investors. A simple trading strategy buying currencies against USD ten days ahead of predicted local interest rate hikes and selling currencies before predicted cuts earns on average a statistically significant return of 42 basis points per ten-day period. We further demonstrate that this return is robust to the choice of holding horizon and monetary policy forecast rule. Our results thus pose a major challenge for the risk-based explanations of the exchange rate dynamics.

Keywords: Monetary Policy, Policy Expectations, Predictability, Overnight Index Swap, Foreign Exchange

JEL Classification: E43, E52, E58, F31, G12

Suggested Citation

Borisenko, Dmitry and Pozdeev, Igor, Monetary Policy and Currency Returns: The Foresight Saga (October 24, 2017). University of St. Gallen, School of Finance Research Paper No. 2017/08. Available at SSRN: https://ssrn.com/abstract=2983043 or http://dx.doi.org/10.2139/ssrn.2983043

Dmitry Borisenko

University of St. Gallen ( email )

St. Gallen
Switzerland

Igor Pozdeev (Contact Author)

New York University Stern School of Business ( email )

44 West 4th Street
New York, NY NY 10012
United States

University of Saint Gallen, School of Finance ( email )

Rosenbergstrasse 52
St.Gallen, CH-9000
Switzerland

Register to save articles to
your library

Register

Paper statistics

Downloads
152
rank
176,580
Abstract Views
744
PlumX