Housing Cycles and Exchange Rates

Abstract

This paper documents that the ratio of residential-to-nonresidential investment is a strong in-sample and out-of-sample predictor for the dollar up to twelve quarters. The predictability is robust to a battery of additional checks and holds for other G10 currencies. We explain the predictability in an analytical model with stochastic volatility and endogenous investment. In the model, the U.S. housing investment share is higher during periods of a strong dollar and low domestic uncertainty, indicating lower future dollar changes and dollar premium. We find strong empirical support for the channel. Alternative explanations, including the business and financial cycle, find less empirical support.

Keywords: housing, exchange rate, predictability

JEL Classification: F31, F37, G150, G17