Discover the Secret Role of US News in Driving Global Markets and Make Money Investing Now
Christoph E. Boehm and T. Niklas Kroner Board of Governors of the Federal Reserve System February 2023
*The full article is available via audio book on YouTube above, read along.
In todays The Tweetsift Report. I’ll be breaking down this https://www.federalreserve.gov/econres/ifdp/files/ifdp1371.pdf
Papers Purpose: The paper contributes to the understanding of the global financial cycle and the role of US macroeconomic news in driving it.
The Board of Governors of the Federal Reserve System's International Finance Discussion Papers 1371 (February 2023) examines the global financial cycle and its external source of financial and macroeconomic volatility for countries with open capital accounts.
The paper establishes a link between the US economy and the global financial cycle, showing that US monetary policy drives global risk appetite and equity prices.
US macroeconomic news has significant impacts on various asset prices, including commodity prices, exchange rates, the 10-year Treasury yield (inverted yield curve), equity premium (stock prices), and expected future dividends (some companies have cut dividends by 60%+).
The Board of Governors of the Federal Reserve Systems’s International Finance Discussion papers suggests that the unique position of the US economy in the global financial system and the limited role of common shocks are the main drivers of the observed asymmetry (any news or information about the US economy tends to have a more significant impact on financial markets and economies around the world) in the effects of US and foreign news releases.
The global financial cycle is characterized by co-movements in gross flows, asset prices, leverage, and credit creation that are closely linked to fluctuations in the VIX.
Non-monetary US news plays a central role in driving the global financial cycle and has a direct effect on the risk-taking behavior of international investors.
US macroeconomic news has a significant impact on commodity prices, exchange rates, and various asset prices, including the 10-year Treasury yield, equity premium, and expected future dividends.
The lack of symmetry in the effects of US and foreign news releases cannot be explained by differences in timeliness or quality of the releases but rather by the unique characteristics of the US economy and its news effect on the macro.
The Fed has a uniquely strong impact on global equities compared to other central banks, and the growth expectations and hedging premium channels are dominant in explaining the joint behavior of stock prices and government bond yields.
Positive real activity and price news are associated with an increase in future short-term rates, contributing to the rise in the 10-year Treasury yield, with the hedging premium channel being the key mechanism behind these results.
How We Can Use this to Make Money Investing
The US news on other implied volatility indexes, including reports on Capacity Utilization, Consumer Confidence, Core CPI, Core PPI, Durable Goods Orders, GDP, Initial Jobless Claims, ISM Mfg Index, New Home Sales, Nonfarm Payrolls, Retail Sales, and UM Consumer Sentiment drive global markets the most and the price of equities. Keep an eye on these by subscribing to Tweetsift so you don’t have to read the https://bls.gov and https://federalreserve.gov yourself.
The effects of monetary policy (interest rates, printing money, taking money back out of the supply) on commodity prices are more pronounced for energy commodities (oil, crude) than for agricultural commodities or industrial metals.
The effects of monetary policy on international stock markets are stronger for developed markets than for emerging markets
The effects of US macro news on commodity prices are stronger during periods of high market volatility and weaker during periods of low market volatility.
The effects of US macro news on international stock markets are stronger during periods of low market volatility and weaker during periods of high market volatility.
The effects of monetary policy on commodity prices are stronger when the US dollar is weak and weaker when the US dollar is strong.
The effects of monetary policy on international stock markets are stronger when the US dollar is strong and weaker when the US dollar is weak.
The effects of monetary policy on commodity prices vary across different types of commodities, with energy commodities being more sensitive to changes in interest rates.
Introduction to the Global Financial Cycle and the Role of US Macroeconomic News
The Board of Governors of the Federal Reserve System's International Finance Discussion Papers 1371 (February 2023) discuss the global financial cycle, which is characterized by co-movements in gross flows, asset prices, leverage, and credit creation that are all closely linked to fluctuations in the VIX. This co-movement constitutes an external source of financial and macroeconomic volatility for countries with open capital accounts.
Non-Monetary US News and Its Role in the Global Financial Cycle
Non-monetary US news also plays a central role in driving the global financial cycle, with evidence pointing to a direct effect on the risk-taking behavior of international investors.
US Macroeconomic News and Its Impact on Asset Prices
The effects of US macroeconomic news on risky asset prices are both large and constitute an important driving force.
The S&P 500 experiences significant positive abnormal returns on days when US macroeconomic news is released, with the effects being more pronounced for bad news affect global financial conditions.
The authors argue that US macroeconomic news is a significant driver of the global financial cycle, and that this is due to the direct effect on the risk-taking behavior of international investors.
The evidence suggests that the S&P 500 does not respond to foreign news releases, indicating a limited role of global common shocks. The paper establishes a link between the US economy and the global financial cycle, showing that US monetary policy drives global risk appetite and equity prices.
The authors use a research design that isolates conditional variation from US macroeconomic surprises to study the mechanisms through which these shocks affect global financial conditions.
They provide a conceptual framework to explain why foreign stock markets may respond to these surprises, ruling out monetary policy shocks as a factor. Overall, the paper contributes to the understanding of the global financial cycle and the role of US macroeconomic news in driving it.
Impact of US News on Commodity Prices and Exchange Rates
We find that US news releases have a significant impact on commodity prices, with positive news leading to an increase in prices and negative news leading to a decrease. The effect is strongest for crude oil, followed by gold and silver.
We also find that the impact of US news on commodity prices varies across countries, with some countries showing a stronger response than others.
US Monetary Policy and its Impact on Asset Prices
Finally, we examine the impact of US news on exchange rates, using daily data on spot rates for 11 currencies against the US dollar. We find that US news releases have a significant impact on exchange rates, with positive news leading to an appreciation of the foreign currency and negative news leading to a depreciation.
The effect is strongest for the Canadian dollar, followed by the Australian dollar and the euro. Overall, our results suggest that US macroeconomic news releases have important spillover effects on global financial markets, and that these effects vary across asset classes, countries, and currencies.
Asymmetry in the Effects of US and Foreign News Releases
Measured as the absolute difference between the first and final estimate of the released data. The results show that the asymmetry in the effects of US and foreign news releases cannot be explained by differences in timeliness or quality of the releases.
Instead, the authors suggest that the unique position of the US economy in the global financial system and the limited role of common shocks are the main drivers of the observed asymmetry.
Overall, the regression analysis conducted by Gurkaynak, Kacikoglu, and Wright (2020) highlights the importance of macroeconomic news releases in explaining asset price movements both in the US and in foreign countries.
The inclusion of non-headline news factors leads to a sizable increase in explanatory power, but the estimates should be interpreted as conservative.
The results also suggest a limited role for common shocks and highlight the unique position of the US economy in the global financial system.
Finally, the asymmetry in the effects of US and foreign news releases cannot be explained by differences in timeliness or quality of the releases, but rather by the unique characteristics of the US economy.
The combined real activity news series captures news related to US GDP, employment, and industrial production, while the combined price news series captures news related to US inflation and interest rates.
Our results suggest that US news releases do not have a higher average quality than foreign news releases in units of standard deviations.
Furthermore, we find that the Fed has a uniquely strong impact on global equities compared to other central banks, and that the growth expectations and hedging premium channels are dominant in explaining the joint behavior of stock prices and government bond yields.
Finally, we discuss the role of US monetary policy in driving our results, and find that positive news about US real activity tends to raise stock prices while lowering bond yields, while higher than expected inflation tends to lower stock prices and raise bond yields.
US Macro News and its Impact on the 10-Year Treasury Yield
US macroeconomic news has significant impacts on various asset prices, including the 10-year Treasury yield, equity premium, and expected future dividends.
Positive real activity and price news are associated with an increase in future short-term rates, which contributes to the rise in the 10-year Treasury yield. The hedging premium channel is suggested to be the key mechanism behind these results.
Role of US Dollar Exchange Rate in the Transmission of US Macro News
The US dollar exchange rate is also found to play a crucial role in the transmission of US macro news in international finance.
Inflation news leads to a dollar appreciation. Some countries' stock markets respond more strongly to US macroeconomic news than others, and the effects are present in normal times and not driven by extreme episodes.
US-specific shocks drive international financial conditions, while ECB policy shocks tend to have smaller effects on international equity prices than Federal Reserve shocks.
The paper also examines the role of news shocks in explaining the observed responses of asset prices. Overall, the analysis suggests that US macroeconomic news has a significant impact on global asset prices, but the transmission of these shocks to individual countries depends on a variety of factors, including the size of the country and the degree of integration with the global economy.
The effects of US news on other implied volatility indexes, including Capacity Utilization, Consumer Confidence, Core CPI, Core PPI, Durable Goods Orders, GDP, Initial Jobless Claims, ISM Mfg Index, New Home Sales, Nonfarm Payrolls, Retail Sales, and UM Consumer Sentiment has the most impact.
Comparison of Federal Reserve and ECB Policy Shocks in International Financial Conditions
The paper also discusses the international transmission of news, news on the global financial cycle, with subsections reporting the effects on the yield curve, asset prices, and international capital flows.
Overall, the paper provides a comprehensive analysis of the effects of news on various financial and macroeconomic variables, both domestically and internationally.
Effects of Monetary Policy on Commodity Prices and International Stock Markets
Our analysis of the effects of monetary policy on commodity prices and international stock markets. We find that the effects of monetary policy on commodity prices are more pronounced for energy commodities than for agricultural commodities or industrial metals.
This is consistent with the fact that energy markets are more sensitive to changes in interest rates due to their higher capital intensity.
State-Dependent Effects of US Macro News on Commodity Prices and International Stock Markets
We also find that the effects of monetary policy on international stock markets are stronger for developed markets than for emerging markets.
This suggests that the transmission of monetary policy across borders is more effective in advanced economies with deeper financial markets. We examine the state-dependent effects of US macro news on commodity prices and international stock markets.
We find that the effects of US macro news on commodity prices are stronger during periods of high market volatility, suggesting that investors are more sensitive to news during times of uncertainty.
We also find that the effects of US macro news on international stock markets are stronger during periods of low market volatility, suggesting that investors pay more attention to news during periods of relative calm.
Role of the US Dollar Exchange Rate in the Transmission of Monetary Policy
We investigate the role of the US dollar exchange rate in the transmission of monetary policy to commodity prices and international stock markets.
We find that the effects of monetary policy on commodity prices are stronger when the US dollar is weak, suggesting that a weaker dollar makes commodities relatively more attractive to investors.
We also find that the effects of monetary policy on international stock markets are stronger when the US dollar is strong, suggesting that a strong dollar makes US assets relatively more attractive to foreign investors.
Cross-Sectional Heterogeneity in the Effects of Monetary Policy
We examine the cross-sectional heterogeneity in the effects of monetary policy on commodity prices and international stock markets. We find that the effects of monetary policy on commodity prices vary across different types of commodities, with energy commodities being more sensitive to changes in interest rates than agricultural commodities or industrial metals.
We also find that the effects of monetary policy on international stock markets vary across different regions, with developed markets being more responsive to changes in interest rates than emerging markets.
These results suggest that the transmission of monetary policy is not uniform across different asset classes or regions, and that investors need to take into account these differences when making investment decisions.
Factors Influencing the Effects of News on Stock Prices
Factors can influence the effects of news on stock prices, including the central bank's policy, the state of the economy, and the level of business cycle slack.
The data used in this study comes from Thomson Reuters Tick History and Altavilla et al. (2019), and includes short Sterling futures contracts, Gilt yields, and German bond yields.
The shocks analyzed in this study are consistent with the idea that forward guidance and quantitative easing played a more dominant role since the Great Recession.
The effects of news on stock prices vary across central banks, and can potentially explain the asymmetry documented above.
The study also shows that the average effects of US news on foreign stock markets are larger when the US unemployment rate is high and the FOMC Sentiment Index is low.
Overall, these findings provide valuable insights into the role of central bank policies in shaping global financial markets.
Still statistically significant and economically large. The estimates suggest that a one standard deviation surprise in US real activity leads to a 15-60 basis point increase in the exposure measure to dollar fluctuations.
The results also show that the impact of the surprise varies with the state of the US economy, but not with the state of the foreign economy.
Moreover, the interaction terms of the surprise with the empirical cdf of the US unemployment rate, with the foreign ZLB indicator, and with the FOMC Sentiment Index are all statistically significant.
Findings on the Impact of US Real Activity on Dollar Fluctuation
The US dollar exchange rate is found to be a key variable in international finance, with a depreciation of the dollar improving balance sheets and reducing credit risk for lenders in local banks.
Impact of Dollar Depreciation on Global Liquidity
This reduction in credit risk, in turn, raises banks' lending capacity and improves global liquidity. However, the results suggest that the mechanism by Bruno and Shin (2015) is not dominant, as the US dollar typically appreciates after positive surprises about both US real activity and stock prices.
Exposure to Dollar Valuation Effects across Countries
Finally, the study considers exposure to dollar valuation effects, with the results showing that several countries experience a significant growth in the exposure measure to dollar fluctuations. Ireland, for instance, reaches a value of over 400 percent in 2017 relative to a mean value of around 19 percent.
Conclusion and Overall Findings
Throughout our conversation, we discussed various aspects of monetary policy, its effects on commodity prices and international stock markets, and the role of the US dollar exchange rate in this process. We learned that the effects of monetary policy on different asset classes and regions can vary, and that investors need to consider these differences when making investment decisions.
We also saw that the state of the economy, the level of business cycle slack, and central bank policies can all influence the effects of news on stock prices. Furthermore, the US dollar exchange rate is a key variable in international finance, with a depreciation of the dollar improving balance sheets and reducing credit risk for lenders in local banks.
Overall, our discussion highlights the complex and interconnected nature of the global financial system, and the important role that monetary policy plays in shaping it. Investors, policymakers, and academics must continue to study and understand these dynamics in order to make informed decisions and promote stable economic growth.