US Interest Rate Surprises and Currency Returns

Abstract

Currencies that are more exposed to US monetary policy yield positive average excess returns. This result holds both for pure monetary policy shocks and for central bank information shocks, identified via sign restrictions on interest rate surprises using high-frequency data. Currency characteristics help explain the heterogeneity of these exposures across currencies and time. We build exposure indices to gauge this effect around policy announcements. Long-short trading strategies that condition on such exposure indices display significant excess returns after controlling for dollar, carry, and momentum factors.

Keywords: Foreign exchange, monetary policy shocks, central bank information shocks, interest rate differentials, carry

JEL Classification: F31, G12, G15