Working Paper: CEPR ID: DP13869
Authors: Andrew Lilley; Matteo Maggiori; Brent Neiman; Jesse Schreger
Abstract: The failure to find fundamentals that co-move with exchange rates or forecasting models with even mild predictive power – facts broadly referred to as “exchange rate disconnect” – stands among the most disappointing, but robust, facts in all of international macroeconomics. In this paper, we demonstrate that U.S. purchases of foreign bonds, which did not co-move with exchange rates prior to 2007, have provided significant in-sample, and even some out-of-sample, explanatory power for currencies since then. We show that several proxies for global risk factors also start to co-movestrongly with the dollar and with U.S. purchases of foreign bonds around 2007, suggesting that risk plays a key role in this finding. We use security-level data on U.S. portfolios to demonstrate that the reconnect of U.S. foreign bond purchases to exchange rates is largely driven by investmentin dollar-denominated assets rather than by foreign currency exposure alone. Our results support the narrative emerging from an active recent literature that the US dollar’s role as an international and safe-haven currency has surged since the global financial crisis.
Keywords: capital flows; risk; exchange rates; reserve currencies
JEL Codes: E42; E44; F3; F55; G11; G15; G23; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| macroeconomic fundamentals (E66) | exchange rates (F31) |
| US foreign bond purchases (G15) | exchange rates (F31) |
| global risk appetite (G40) | US foreign bond purchases (G15) |
| global risk appetite (G40) | exchange rates (F31) |
| US foreign bond purchases (G15) | exchange rates (F31) |