Central Europe: The impact of macro news and central bank ... · 1st stage - Modeling equillibrium...

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3/1/2018 1 The impact of macro news and central bank communication on emerging European forex markets Balázs Égert, OECD, Economics Department Evžen Kočenda, Charles University, Prague Central Europe: Motivation: Empirical evidence of the effects of macro news and central bank communication on exchange rates Research focuses on developed countries Emerging markets, where exchange rates are more volatile are much less explored and one of the major reasons is the lack of data But… higher volatility plus reactions of exchange rates to fundamentals and central bank communication, is crucial with regard to financial investment flows. Focus on three Central European (CE) currencies where the above issue is grossly under-researched despite the fact that the region attracts considerable amounts of foreign investments: Jotikasthira et al. (2010) show that developed-country-domiciled mutual and hedge fund holdings account for about 14–19% of the free-float adjusted market capitalization in Central Europe Specifically, 16.59% in the Czech, 16.98% in the Hungarian and 13.29% in the Polish equity markets. Objective: Investigating drivers of daily foreign exchange returns in Central Europe during 2004-2009 Effect of macroeconomic announcements on fundamentals Effects of central bank communication Pre-crisis and crisis periods in our equilibrium exchange rate model we employ an array of the explanatory variables to allow for different angels in exchange rate modeling Accounting for possible nonlinearities: non-linear modeling framework, which allows the exchange rate to move back to the monetary equilibrium at different speed depending on the size of the deviation from equilibrium

Transcript of Central Europe: The impact of macro news and central bank ... · 1st stage - Modeling equillibrium...

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The impact of macro newsand central bank communication

on emerging European forex markets

Balázs Égert, OECD, Economics DepartmentEvžen Kočenda, Charles University, Prague

Central Europe:

Motivation:

Empirical evidence of the effects of macro news and central bank communication on exchange rates

• Research focuses on developed countries• Emerging markets, where exchange rates are more volatile are much

less explored and one of the major reasons is the lack of data• But… higher volatility plus reactions of exchange rates to

fundamentals and central bank communication, is crucial with regard to financial investment flows.

• Focus on three Central European (CE) currencies where the above issue is grossly under-researched despite the fact that the region attracts considerable amounts of foreign investments:

– Jotikasthira et al. (2010) show that developed-country-domiciled mutual and hedge fund holdings account for about 14–19% of the free-float adjusted market capitalization in Central Europe

– Specifically, 16.59% in the Czech, 16.98% in the Hungarian and 13.29% in the Polish equity markets.

Objective:

Investigating drivers of daily foreign exchange returns in Central Europe during 2004-2009

Effect of macroeconomic announcements on fundamentals

Effects of central bank communication

Pre-crisis and crisis periods

• in our equilibrium exchange rate model we employ an array of the explanatory variables to allow for different angels in exchange rate modeling

• Accounting for possible nonlinearities: non-linear modeling framework, which allows the exchange rate to move back to the monetary equilibrium at different speed depending on the size of the deviation from equilibrium

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The role of fundamentals: Macroeconomic fundamentals are important for exchange rate

movements:Persuasive evidence on effects of the news that are incorporated in FX witha considerable speed (Chaboud et al, 2004)Negative news has a larger impact that positive news of the same magnitude(Andersen et al, 2003; Galati and Ho, 2001; and Laakkonen, 2007)Effects change over time and differ with specific type of macroeconomicnews (Galati and Ho, 2001; Edison, 1996; Ehrmann and Fratzscher, 2007)

Surprise component of macroeconomic news (real timefundamentals)Effect varies over time (Galati and Ho, 2001)Effect is different for different macroeconomic news (Edison, 1996; Ehrmannand Fratzscher, 2005)Macro news explain a large number of directional changes in the euro/dollarexchange rate (Ehrmann and Fratzscher, 2005)

Nonlinear adjustment to (long-term PPP) equilibrium:Allows the exchange rate to move back to the monetary equilibrium atdifferent speed depending on the size of the deviation from equilibrium

The impact on exchange rate is not straightforward

ECB official statements move the FX (Fratzscher, 2004, 2005)

ECB communication only increased FX volatility (Jansen and de Haan, 2003)

Effect is small if combined with macro news releases (Jansen and de Haan,2005)

Results differ because of different estimation techniques, alternative coding ofcentral bank communication (Siklos and Bohn, 2007)

The role of central bank communication:

First attempt to analyse the impact of macroeconomic news and centralbank communication on the exchange rate of three Central Europeancurrencies [Czech koruna, Hungarian forint, Polish zloty].

(1) Evidence on the determinants of the short-term FX movements

(2) Employ an array of the explanatory variables to allow for different angels in

exchange rate modeling

(3) Use a large set of the accurately identified macroeconomic news and central

bank communications that was not employed in FX analysis of the CE

currencies so far.

(4) Employ a non-linear modeling framework allowing exchange rate to move

back to the monetary equilibrium at different speed

Contribution of the paper: Modeling strategy: two stages

First, we use the monetary model to compute long-run equilibriumexchange rates.

Second, we estimate high-frequency exchange rate models byincorporating the deviation from the monetary equilibrium,macroeconomic news, central bank communication and a set ofcontrol variables.

The idea of the two-stage approach is to produce daily interpolationsof the long-term exchange rate that is in line with monetaryfundamentals, from which deviations can be observed easily.

This is a similar method as that of Fidrmuc and Horváth (2008) whouse the deviations from a long-term average of daily exchange ratesin a conditional volatility equation.

Our approach expands theirs by using the deviations from long-termvalues in the mean equation and by providing a more structuralassessment of the long-term value of the nominal exchange rate.

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Modeling strategy: 1st stage - Modeling equillibrium

Standard monetary model:

Extend the basic model by including the productivity differential andrelative price of non-tradable goods with respect to the tradablegoods to capture the Balassa-Samuelson effect

Long-term relationship estimated with DOLS

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Modeling strategy: 2nd stage – High frequency exchange rate modeling Data: Monetary model (2004:m1-2009:m12)

NOMINAL EXCHANGE RATES: monthly averages domestic currency/euro obtained from EurostatM2 for CZE and M3 for the euro area, HUN and POL obtained from Eurostat

SHORT-TERM INTEREST RATE (3-month T-bill): 3-month money market rates for the CZE, POL and the euro area and 3-month T-bills for HUN, data obtained from IFS/IMF

PRODUCTIVITY DIFFERENTIAL: Industrial production in manufacturing divided by employment in manufacturing

INDUSTRIAL PRODUCTION: IFS/IMF for CEE and from Eurostat for the euro area

EMPLOYMENT IN INDUSTRY/MANUFACTURING: Industry in the CEE countries and in manufacturing for the euro area

PRICES, CPI and PPI: Obtained from IFS/IMF for CEE countries

NOMINAL GDP (interpolated linearly from quarterly to monthly): OECD Quarterly National Accounts database for CZE, HUN and POL and OECD Main Economic Indicators database for the euro area

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(1) Exchange rates:

• DataStream: daily quotes with respect to euro, 2004-2009

• Bubák et al. (2011) show that the three currencies under research exhibit different patterns across the pre-crisis period before 2007 and crisis period afterwards

• Two sub-samples (2004-2007 and 2008-2009) to account for crisis

Data:

(2) Macroeconomic announcements: 10 types of news divided into 3 categories:

(i) prices: CPI, PPI

(ii) real economy: industrial production, GDP, retail sales, trade balance, currentaccount, unemployment

(iii) monetary policy: monetary aggregate, interest rate

Macro news are usually reported on a monthly basis with the exception of the GDPthat is reported quarterly

Modelling the news: excess impact perspective (Hanousek and Kočenda, 2011)

xnit = (snit – Et-1[snit]) / σi

plus standardization since announcements are often reported in different units

Macroeconomic announcements enter estimation as continuous variablesand are coded in a way that improvement above market expectations (positivesurprise) brings the estimated effect

Data:

(3) Central bank communication on exchange rate:

Verbal and press release communication news from Factiva (Dow JonesCompany); Examples:

Data:

Date Central bank communication Expected effect onFX:

26 June, 2008 Following are key comments of the Czech Central BankGovernor Zdenek Tuma after the decision: "In my opinion,such a strong crown firming is not something that anyeconomy would be able to withstand in a longer term. Idare to say that we do not have such a high productivitygrowth."

Weaken

17 December,

2008

Poland's central bank governor Slawomir Skrzypek said onWednesday there may be a need for currency marketinterventions because of the zloty's sharp depreciation.Headded he was not a fan of such a solution but that he wasworried about the weakening zloty.

Strengthen

Data: Central Bank communications

Czech koruna Hungarian forint Polish zlotyYear strengthen weaken stable strengthen weaken stable strengthen weaken stable2004 1 2 8 2 1 10 6 4 42005 0 4 4 1 4 11 2 6 22006 0 8 0 6 1 12 1 2 12007 1 6 1 0 3 15 2 1 22008 0 12 3 9 0 9 2 2 22009 5 4 6 13 4 11 8 0 8

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Estimation• 1. monetary model estimation

– Series of estimation during which we initially estimate our benchmark model that contains relative money supply and relative output

– Later we augment the benchmark model by adding additional explanatory variables – industrial production, short-run interest rate, relative price of non-tradable goods, and labor productivity

– Based on the Schwarz Information Criterion we select a specific model for each country that will be used for the short-run exchange rate model

– error correction terms from the DOLS models are negative a statistically significant (a weak cointegration)

– Coefficients of the explanatory variables are all statistically significant and exhibit intuitively correct signs

• 2. we estimate the high-frequency GARCH models– degree of responsiveness during the pre-crisis and crisis periods– For each currency we estimate GARCH(1,1) models with the mean equation

augmented by the set of news, central bank communications, and day-of-the-week effect dummies

– the linear, two-regime, and three-regime models are estimated to allow for differences due to a) nonlinearity in deviation from monetary equilibrium, and b) alternative interpolation of the monthly deviation series to the daily frequency (linear and cubic interpolation)

– Based on our model specification tests (Hansen, 1999) we estimate models where deviation from monetary equilibrium is compared to actual fit and linear interpolation to daily frequency is used

Results: High frequency model, pre-crisis period, 2004-2007

Variable: Czechkoruna

Hungarianforint

Polishzloty

Constant -0.004 -0.138* -0.003**∆et-1 -0.025 -0.026 -0.092**Macroeconomic surprises: CPI -0.053 -1.018 -0.016PPI -0.173* 0.330** -0.024**GDP -0.022 -0.006Current account 0.007 -1.229** -0.014**Trade balance 0.006 -0.113Industrial production -0.001Retail sales -0.002 0.403 -0.009**Unemployment 0.156**Money 0.000Policy rate -0.050 -1.823 -0.036*Central bank communication: strengthen -0.025 -0.325 -0.004weaken -0.018 0.352 -0.006**stable -0.005 -0.533 -0.006*Day-of- the-week dummies: Tuesday 0.007 0.076 0.003*Wednesday 0.000 0.169* 0.006**Thursday -0.001 0.176* 0.003Friday -0.007 0.112 0.002USD/EUR cross rate -0.145 -12.929** -0.112Interest rate differential -0.002 0.019 0.002Emerging market risk 0.003** 0.109** 0.002**

Deviation from monetary model 0.003 2.742* -0.004

Implication of results: pre-crisis period (2004-2007)

News on producer prices: the single most important type

coefficients statistically significant across all three currencies lover than expected inflation contributes to appreciation of the Czech and

Polish currencies

Opposite for Hungarian forint (subject to exchange rate regime managed tomake the forint stable vis-à-vis to euro

Intuitive reaction to the news on current account: Hungarian and Polish currencies negative coefficients are in line with the theory (Dornbusch and Fischer, 1980)

improved retail sales: contribute to appreciation of the Polish currency

Increase in retail sales can be directly translated into increaseddemand for tradable goods and currency to pay for it

importance of retail sales in line with the evidence in Kočenda and Poghosyan(2009) who show its positive effect on the risk premium of the Polish zloty

Surprise component of the unemployment announcements contributes to thedepreciation of the Czech currency in an extent comparable to that of theindustry prices.

Implication of results: pre-crisis period (2004-2007)

Effect of the the central bank communications is limited on the Polishcurrency

Statements intended to weaken the currency seem to contribute to itsmarginal appreciation instead.

Czech and Hungarian currencies do not show responses to central bank communications, as respective coefficients are insignificant

Fratzscher (2008) shows that communications produce less impact and are less effective when exchange rate is close to equilibrium level and market uncertainty is low

Czech currency: traded more heavily on the international forex market than other CE currencies; reflect more market forces than macro news and bank communication

Hungary: dual nature of the monetary policy framework (inflation targeting and exchange rate stability with respect to the euro) complicate effectiveness of the central bank communications

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Results: High frequency model, crisis period, 2008-2009

VariableCzechkoruna

Hungarianforint

Polishzloty

Constant -0.009 0.018 0.003∆et-1 0.043 -0.044 0.055Macroeconomic surprises: CPI 0.106 -3.520 -0.031**PPI -0.063 0.037 0.010GDP -0.189** -0.114**Current account -23.511 2.928 0.007Trade balance -0.049 1.866Industrial production -0.001Retail sales 0.006 -1.448 0.001Unemployment 0.791Money -0.012Policy rate -0.094 8.888 0.113Central bank communication: strengthen -0.122** -0.309 0.001weaken 0.014 -1.700** 0.006stable 0.020 0.556 -0.108**Day-of- the-week dummies: Tuesday -0.004 -0.161 -0.005Wednesday 0.028 0.211 -0.002Thursday 0.030 0.195 -0.003Friday -0.001 0.249 -0.005USD/EUR cross rate -1.907** -54.551** -0.574**Interest rate differential -0.020 0.027 -0.002Emerging market risk 0.001 0.117** 0.002**

Deviation from monetary model -0.092 4.647 -0.084*

Implication of results: crisis period, 2008-2009

The pattern of the responses to both macroeconomic announcements aswell as central bank communications radically changes.

During the severe crisis the markets cease to react to macro news andcurrencies respond only to the most important information about theeconomic development that is news on the GDP.Surprise improvements in the aggregate output create a strong appreciatory effect on Czech and Polish currencies, while lack of variation precludes inference for the Hungarian forint.Lack of responses is in line with Cai et al. (2009) who show that market uncertainty dampenes more news than it amplifies

Implication of results: crisis period, 2008-2009

Improved rsponsivness on central bank communications (all three currencies)

strengthening announcements have produced desired response for the Czech koruna

weakening announcements delivered strong appreciation effects for Hungarian forint

markets either misinterpreted the announcement or they did not care and othereffects dominated

mix of clear and complicated statements

Communications aimed at stability of the currency produce appreciatory effect inPolish zloty.

Conclusions:

Remarkably different reactions to macroeconomic announcements and centralbank communications before and during the severe economic crisis

During the pre-crisis period (2004-2007) the major CE currencies in generalrespond to various macro news in an intuitive manner that corresponds toexchange rate related theories as well

During the crisis (2008-2009) the responsiveness breaks down and thecurrencies react to the news on the key economic indicator (GDP)

There is a lack of responsiveness during the pre-crisis period (with the exceptionof the Polish currency) with regard to the central bank communications

All currencies react to central bank oral interventions during the crisis

Exchange rates of the CE currencies are responsive to both macro news andcentral bank communications but this responsiveness differs during pre-crisisand crisis periods.

Detailed responses vary across the currencies driven by exchange rate regimeand extent to which particular currencies are traded on international forexmarket

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INTRADAY EFFECT OF NEWS ON EMERGING EUROPEAN FOREXMARKETS: AN EVENT STUDY ANALYSIS

Evžen KočendaMichala Moravcová

Motivation• Macroeconomic fundamentals FX rate movements (Cavusoglu, 2011)

• Macroeconomic news produce about 15% FX rates’ variation

(Fratzscher, 2006; Laakonen, 2007)

• Evidence: developed mkts, the pre-2008 crisis period, (G)ARCH-type models

• Emerging mkts: Foreign macro news greater impact than domestic news

(Andritzky et al. (2007), Büttner et al. (2012), Balcilar et al. (2016))

• Mostly examined US news on emerging markets

• Empirical data suggests close connection of new EU markets with Eurozone

and Germany (Hayo et al. (2010)); substantial positive spillover effects from

German financial market to Czech market (Hanousek et al. (2009))

Data• We analyze:

Effects of foreign macroeconomic news announcements and

monetary policy settings on FX rates of new EU countries using ESM

CZK/EUR, PLN/EUR, HUF/EUR and CZK/USD, PLN/USD, HUF/USD

• Intraday 1 minute log returns

• Sample period: 3rd January 2011 – 31st December 2015

• Why FOREX?

1. opened 24 hours capture effect of news released when stock market is

closed

2. The most liquid financial market avoid the problem of market

microstructure noise (stocks with low liquidity/emerging markets)

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Data• Macroeconomic news - extensive data set on 22 different

macroeconomic news from the Eurozone/Germany and USA

• News divided into 4 categories

(Good News, Bad News, Neutral News, All)

• Effect of news from the excess impact perspective

• The time difference between the European and U.S.

financial markets is accounted by setting homogenous CET

time for all news (DST is considered)

German/Eurozone and U.S. macroeconomic news release calendar

Examined macroeconomic events

Eurozone/Germany USA

Monetary Policy DecisionsExtra loose monetary policyChanges in monetary policy settings mostly related to monetary expansionOnly examined days when central banks took action

ECB Fed

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Event Study Methodology Approach

Pre event

windowEvent

window

-135 min

news announcements

0 20 min-5 min-6 min

Event Study Methodology Approach• Event’s impact assessed by abnormal returns.

rit actual return

E[rit/xit] expected return given the conditioning information xit for expected

return model

• No autocorrelation is found in the currencies’ returns Constant Mean

Returns Model (CMRM)

μi mean return for asset i

ξit time period t disturbance for event i with expectation of zero (E(ξit) = 0),

var. (ξi ) = σζi2

Event window - increasedvolatility of ARsTo control for this phenomenonstandardized abnormal returnsare used instead of estimatedones(Corrado, 2011; Corrado &Truong, 2008)

Standardized abnormalreturns are adjusted in orderto control for the event -induced change in thecross-sectional variance

Event Study Methodology Approach Event Study Methodology Approach

Rank test of Corrado and Zivney (1992) statistical

significance of mean abnormal

returns in the event window

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Rank test• Statistical test using the statistical ranks of data points• Rank is an ordinal number of a value in an interval and is

arranged in a specified order (decreasing, increasing)• Corrado and Zivney test:

• Statistical difference between returns before and during event window

• nonparametric test - no assumption about the normality• robust both against event-induced volatility and to cross-correlation

due to event day clustering

Confounding event problem• Two or more indicators released on the same day

• If they are released during one hour:

1. contradictory information – only 1st news considered

2. not contradictory information: all news considered

• More than one hour time spam: all news considered

Note: (Egert and Kočenda (2011) show that crucial impact of news

entering the market does not last longer than five minutes and remaining

effect fully vanishes after another 20 minutes

Hypothesis and Results• Hypothesis 1:

• Macroeconomic news (for German/Eurozone and U.S. economies) do

not affect the value of new-EU-country exchange rates.

• Results: Reject Hypothesis1:

• Macroeconomic news from both continents exhibit short-term effects

affecting the value of new-EU-country FX rates.

• USD denominated FX rates show higher abnormal returns than euro-

denominated currency pair.

• The strongest reaction – US denominated FX rates - NFP and GDP

Hypothesis 2: The origin of an announcement is irrelevant with respect to its effect on the value of quoting new-EU-country currenciesReject

Euro-denominated exchange rates : i. smaller ARs’ valuesii. Nb. of statistically

significant ARs loweriii. larger ARs are

generally linked with good news

dollar-denominated exchange rates :i. ARs values largerii. statistically

significant ARs occur often

iii. statistically significant ARs occur later

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Hypothesis and Results:• Hypothesis 3: There is no difference among types of macroeconomic

news announcements with respect to their effect on the value of new-

EU-exchange rates.

• Results: Reject Hypothesis 3:

• Strong statistically significant reaction of all U.S. dollar-denominated

exchange rates to good news of the NFP, PMI Non-man. index, Retail

Sales, Core Durable Goods Orders 1 minute before announcement.

• Smallest number of statistically significant returns after Ind. Production,

CPI, PPI, Trade Balance

Hypothesis and Results:

Euro denominated FX rates USD denominated FX rates

Hypothesis 4: There is no difference in the qualitative direction of news announcement (good, bad, or neutral) with respect to the effect on the value of new-EU-country exchange ratesResults: Reject Hypothesis 4

Hypothesis and Results:• Hypothesis 5: There is no difference in the market reaction before and

after the news announcement.

• Results: Reject Hypothesis 5:

• In euro-denominated FX rates ARs are significant even before the bad

news of PMI, Retail Sales, Trade Balance for CZK/EUR, HUF/EUR

• One minute before news announcement - strong statistically significant

reaction of all U.S. dollar-denominated exchange rates to the good news of

NFP, PMI Non-man. index, Retail Sales, Core Durable Goods Orders

Hypothesis 6: The new-EU-country currency market is efficient.New public information is incorporated quickly into asset prices. The effect of news announcements is visible for a very short time

Results: Cannot reject Hypothesis 6:

CARs:new public information is quite quickly incorporated into the currency pricesLow values for EUR denominated returns

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Hypothesis and Results:• Hypothesis 7: Announcements about ECB or Fed monetary policy

settings do not affect the value of new-EU-country currencies.

• Results: Reject Hypothesis 7: The impact of U.S. monetary policy

changes is present, but less significant than that ECB monetary policy

ECB monetary policy

Fed monetary policy EU debt crisis (3.1.2011- 26.7.2012)