The “de-anchoring” of inflation in the euro area

April 16, 2016

Two recent empirical studies highlight the risk that inflation expectations in the euro area are becoming de-anchored, similar to Japan. De-anchoring means that short-term price shocks can change long-term expectations. Importantly, the papers suggest medium- and short-term measures to track this de-anchoring. De-anchoring increases the risk of actual deflation and may add to the risk premia on equity and credit.

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Using commodity prices to predict exchange rates

April 9, 2016

A new empirical study confirms that export price changes explain a substantial part of commodity currency fluctuations, particularly at high frequencies. More importantly, country-specific export price indices help predicting commodity countries’ future exchange rate dynamics. The predictive power appears to be most robust over a horizon of one month.

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How to measure economic uncertainty

March 19, 2016

Measures of economic uncertainty help investors to track popular fear or complacency for the purpose of trading strategies. Academic papers propose various methods: keyword frequencies in news, equity market volatility, earnings forecast dispersion and economic forecast disagreements. Composite measures suggest that uncertainty typically rises abruptly but declines just gradually.

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Rational informational herding

February 27, 2016

It can be rational for traders to buy with rising prices and sell with falling prices. In particular, this should be the case if traders possess private information suggesting that “something big” is coming and that prices may move significantly, even if direction is not certain (e.g. “make-or-break” situations). Experiments confirm such rational informational herding.

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EM exchange rates and self-reinforcing trends

February 6, 2016

Emerging market exchange rates can be catalysts of self-reinforcing trends. Currency appreciation raises both global lenders’ risk limits and EM institutions’ debt servicing capacity. Currency depreciation spurs the reverse dynamics. Their escalatory potential constrains central banks’ tolerance for exchange rate flexibility.

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The secular decline in the global equilibrium real interest rate

January 2, 2016

A new Bank of England paper finds a 450 bps decline in global equilibrium real interest rates over the past 35 years, due to a fundamental divergence: savings preferences surged on demographics, inequality and EM reserve accumulation, while investment spending was held back by cheapening capital goods and declining government activity. More recently, fear of secular stagnation has compounded the real rate compression.

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Momentum trading and setback risk

December 19, 2015

An empirical study suggests that momentum trades yield positive returns but carry higher downside than upside market risk. This “beta asymmetry” appears to be a global phenomenon across asset classes.  It is consistent with the broader observation that popular trading strategies come at the price of setback risk related to the crowdedness of positions.

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Using volatility to predict crises

December 12, 2015

A long-term empirical study finds two fundamental links between market volatility and financial crises. First, protracted low price volatility leads to a build-up of leverage and risk, making the financial system vulnerable in the medium term (Minsky hypothesis). Second, above-trend volatility indicates (and causes) high uncertainty, impairing investment decisions and raising the near-term crisis risk.

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Tracking trends in EM economies

November 28, 2015

Two recent papers provide useful techniques for “nowcasting” EM economies. The first uses “dynamic factor models” with high frequency indicators to estimate GDP growth in countries with scant and noisy data. The second uses seasonal adjustment with modifications for time-varying holidays that can track underlying trends in China and other countries with lunar year and Islamic holidays.

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The short-term effects of U.S. economic data releases

November 14, 2015

A two-decade empirical study shows that bond and equity market prices are more likely to “jump” on days with U.S. economic data releases. In particular, surprises in news announcements tend to lead to higher volatility and larger price moves. The impact of key data surprises on bond markets seems clearer and simpler. The impact on equity markets depends on the state of the business cycle

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