Press Release

Economic Policy Review: Analyses of Exchange Rate Dynamics and Treasury Market Trends

April 22, 2004
Note To Editors

The latest edition of the Federal Reserve Bank of New York’s Economic Policy Review is now available, featuring two articles on exchange rate dynamics and two on the U.S. Treasury market.

The articles are:

Industry-Specific Exchange Rates for the United States
Industry-specific exchange rate indexes are an effective tool for capturing the types of exchange rate movements that affect profits of individual U.S. industries, according to Linda S. Goldberg. The author concludes that these indexes generally are superior to the trade-weighted indexes constructed for the overall U.S. economy because industry-specific rates capture changes in industry-competitive conditions that result from moves in specific bilateral exchange rates.

Goldberg constructs several industry-specific exchange rate indexes for the United States and analyzes the extent to which each index moves with, or diverges from, aggregate economywide measures. She finds that the effect of U.S. dollar moves on profits can be more precisely identified when using the industry-specific indexes: dollar appreciations reduce corporate profits, while depreciations stimulate them. Broader exchange rate indexes fail to capture the majority of the moves.

The database with industry-specific exchange rates for the United States, and the alternative construction methods for different applications, is available online.

Industry Specific Exchange Rates ››

Linda S. Goldberg is a vice president and economist at the Federal Reserve Bank of New York.

Exchange Rate Changes and Net Positions of Speculators in the Futures Market
Research by Thomas Klitgaard and Laura Weir finds a strong and stable contemporaneous relationship between weekly changes in the net positions of futures market speculators and exchange rate movements, but that such data do not appear to be useful in anticipating such changes over the following week.

Klitgaard and Weir note that macroeconomic models--which often are based on interest rates, prices, and GDP--can help explain exchange rate changes over long horizons, but do a poor job of tracking daily, weekly, or monthly changes. Economists, taking a cue from currency traders, increasingly are looking at transaction-related data to better understand short-term exchange rate dynamics. One such data set is the net position of speculators in the futures markets. The net position--contracts to buy a foreign currency at a future date minus contracts to sell the same currency--is often watched by market analysts, who interpret its movements as a proxy for speculators’ changing views of the short-term direction of exchange rates.

Klitgaard and Weir use data from the Chicago Mercantile Exchange to analyze the relationship between speculators’ net positions and exchange rates for six currencies from 1993 to 2003. The authors find that knowing the direction of the change in the net position in a particular currency, one would have a 75 percent chance of correctly guessing the exchange rate’s direction over that same week.

Thomas Klitgaard is a research officer and economist and Laura Weir is a vice president at the Federal Reserve Bank of New York.

The Institutionalization of Treasury Note and Bond Auctions, 1970-1975
A new study by Kenneth D. Garbade identifies the 1970-1975 period as a milestone in the U.S. Treasury market’s evolution from fixed-price offerings of notes and bonds to market-driven auctions.

The Treasury traditionally auctioned bills, but prior to 1970 it relied on fixed-price offerings of notes and bonds, in part because two attempts to auction long-term bonds--in 1935 and 1963--had failed. Auction sales generally were considered a more efficient and cost-effective way to offer securities, and the Treasury moved in that direction in the early 1970s.

Garbade offers three reasons for the Treasury’s turnaround:

  • By imitating its well-established bill auction process, the Treasury gave dealers a familiar starting point for developing the risk management and sales programs necessary to support auction bidding for notes and bonds.
  • The Treasury announced auctions for securities of gradually increasing maturities, instead of immediately auctioning long-term bonds. As a result, dealers had sufficient lead time to build their risk management and sales programs.
  • The Treasury was willing to alter the auction process when shortcomings appeared--rather than jettison the entire effort, as it did in 1935 and 1963.

Kenneth D. Garbade is a vice president and economist at the Federal Reserve Bank of New York.

Treasury Inflation-Indexed Debt: A Review of the U.S. Experience
An analysis of Treasury inflation-indexed debt securities (TIIS) since their introduction in 1997 concludes that the securities have yet to fulfill a primary goal: reducing the U.S. Treasury’s expected financing costs.

Brian Sack and Robert Elsasser explain that over most of the post-1997 period, yields on TIIS have been surprisingly high relative to yields on comparable nominal Treasury securities. The spread between indexed and nominal yields has fallen, on average, well below survey measures of long-run inflation expectations.

Sack and Elsasser attribute the low relative valuation of TIIS over this period to several factors: investor difficulty adjusting to a new asset class, divergent supply trends between TIIS and nominal Treasuries, and the lower liquidity of indexed debt. In addition, they observe that investors may have had a benign outlook for inflation and may not have demanded much, if any, of an inflation risk premium to hold nominal securities.

More recently, though, TIIS market liquidity and the breadth of investor participation have increased markedly, and the valuations of TIIS relative to nominal Treasury securities appear to have improved.

Brian Sack is chief of the Monetary and Financial Market Analysis section of the Board of Governors of the Federal Reserve System and Robert Elsasser is a vice president at the Federal Reserve Bank of New York.

Linda Ricci
(212) 720-6143