Macro Man is embroiled in yet another debate with academic-type economists about the impact of central banks in foreign exchange markets. Regular readers will know his view, namely that Voldemort and friends can and do put the EUR/USD rate wherever they dman well please, give or take.
He is now curious to see what FX market professionals, some of whom may read this blog, think of the issue. He has therefore created the poll below on CB impact on exchange rates. He would encourage any readers with knowledge of the currency market to respond, and to pass the link on to their colleagues/customers so as to get as wide a response as possible. Hopefully the poll generates enough responses to either show the academics what they're missing, or to shut Macro Man up about CB interference in private markets.
He is now curious to see what FX market professionals, some of whom may read this blog, think of the issue. He has therefore created the poll below on CB impact on exchange rates. He would encourage any readers with knowledge of the currency market to respond, and to pass the link on to their colleagues/customers so as to get as wide a response as possible. Hopefully the poll generates enough responses to either show the academics what they're missing, or to shut Macro Man up about CB interference in private markets.
4 comments
Click here for commentsThanks for the mapping function -- there may be a lot of (unintended) information there!
ReplyApologies in advance for the length of this comment, but as a former academic turned market participant I feel that there is a lot that needs to be cleared up regarding the influence of central banks (CBs) in FX markets. There are two common misconceptions about CB activity in FX: 1) they are a source of inefficiency because they do not maximize profits and 2) CB flows are irrelevant because past interventions have generally been ineffective and CB volume pales in comparison to the daily FX turnover of USD 2trn.
ReplyRe. 1), though CBs aren't explicit profit maximizers, their bias to contain extremes in exchange rates make them implicit speculators (i.e. they tend to buy low and sell high). Recent studies of the RBA (Becker and Sinclair 2004) and BoJ (Ito 2002) indicate that intervention activity has been hugely profitable (estimates suggest that the BoJ has made JPY 9trn or about 2% of GDP from 1991-2001). The bottom line is that these are large numbers in economic terms.
Re. 2), central bank interventions are often thought of as ineffective because they do not seem to relieve currency pressure/volatility during crisis periods. While the empirical work does seem to bear this out, the current market environment is most certainly not crisis oriented. In a low volatility world, daily exchange rate fluctuations are large relative to weekly or monthly moves. Though USD 2trn may trade on the average day, 60%-80% is done on the interbank market where spot traders are looking to make 20-50 pips risking 10. In that world, CBs dealing even in lots of USD 250-500mio could move EURUSD by 15-40 pips (market impact estimates come from Evans and Lyons 2002).
Thus in a world of low macro volatility, the market impact of relatively small transactions can lead to micro trends/stop-loss runs that are the cause of immense frustration to G3 FX traders. The influence of CBs is further compounded by the fact that portfolio rebalancing means that if EURUSD rallies, they need to sell to maintain target allocations. Though the changes are marginal in percentage terms, the massive size of reserve portfolios means that the dollar amounts are large enough to keep rates in tight ranges.
Anonymous, I believe you're spot on. I've been making similar, albeit less eloquent, points in my sundry debates over at Brad Setser's blog.
ReplyI would go even further re: your point 1, however. While the traditional role of central banks has not been as profit-maximizers, the active portfolio management techniques of many EM CBs (as well as, naturally, sovereign wealth funds), which includes day-trading and option-selling, has essentially taken alpha away from the private sector.
This, I believe, is one of the reason that many popular measures of currency manager performance have been so poor over the past few years.
I view economy's like ocen liner's...you cannot turn them around on a "dime" rather a gradual and slow turn occurs. As such I think that currencies go where they are going. Sure a CB can intervene or slow a trend (the MAS is quite good at this) but overall it will go where ever it is going.
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