Exchange Rate Behavior with Negative Interest Rates: Some Early Negative Observations

Transcription

1 Exchange Rate Behavior with Negative Interest Rates: Some Early Negative Observations Andrew K. Rose Berkeley-Haas, ABFER, CEPR and NBER (joint work with Allaudeen Hameed)

2 Motivation In last decade, five economies experienced (non-trivial) negative nominal interest rates Denmark, EMU, Japan, Sweden, Switzerland Most focus on consequences of Negative Interest Rate Policy (NIRP): Growth, inflation Bank profitability, micro-structural effects Financial Stability Here, focus on exchange rate behavior Volatility, Uncovered Interest Parity Deviations (UIP) Literature: little work, no strong results Negative Nominal Interest Rates and Exchange Rates 2

3 Summary of Findings Negative Nominal Interest Rates have almost no observable consequences for exchange rate behavior Exchange Rate Volatility Deviations from Uncovered Interest Parity Carry Trade Returns Negative Nominal Interest Rates and Exchange Rates 3

4 Data Set Time span short, hence maximize scope of necessarily limited data set Include 61 currencies/economies countries Begin January 2010 (post GFC), continue through May 2016 Daily (highest frequency with many countries) Switzerland usually base First negative nominal rates; longest span of time; most negative rates Sensitivity with US$, GBP, Euro as alternatives Negative Nominal Interest Rates and Exchange Rates 4

5 Country List Argentina Australia 1 Bahrain 3 Brazil Botswana 4 Bulgaria 3 Canada 1 Chile China 2,4 Colombia Croatia 4 Czech. Rep. 1,4 Denmark 1,3 Egypt 4 EMU 1 Estonia 1,3 Ghana Hong Kong 1,2,3 Hungary Iceland 1 India 2 Indonesia 2 Israel 1 Japan 1,2 Jordan 3 Kazakhstan 2,4 Kenya Korea 1,2 Kuwait 3 Latvia 1,3 Lithuania 1,3 Malaysia 2 Mexico Morocco 3 Norway 1 New Zealand 1 Oman 3 Pakistan 2 Peru Philippines 2 Poland Qatar 3 Romania Russia Saudi Arabia 3 Serbia Singapore 1,2 South Africa Sri Lanka 2 Sweden 1 Switzerland Taiwan 1,2 Thailand 2 Tunisia 4 Turkey 2 Uganda UK 1 United Arab Rep. 3 USA 1 Vietnam 2,4 Zambia Negative Nominal Interest Rates and Exchange Rates 5

6 First Look Swiss interest rates go negative briefly in August 2011 Follows sudden Swiss Franc appreciation SNB diagnoses massive overvaluation, loosens to protect competitiveness, reduce deflationary pressure September 2011: SNB places floor on Euro/Swiss Franc exchange rate January 2015: exchange rate constraint removed, jump appreciation, NIRP begins in earnest Negative Nominal Interest Rates and Exchange Rates 6

7 Swiss Interest and Effective Exchange Rates Interest Rate Swiss Interest and Effective Exchange Rates Interest Exchange 01 Jan Jan Jan Jan 16 LIBOR 1-month interest rate; EER index from Bank of England; 1990= Exchange Rate Negative Nominal Interest Rates and Exchange Rates 7

8 Bilateral (Swiss) Exchange Rates and National Interest Rates Swiss Exchange and National Interest Rates American interest Interest United States Exchange 8/2011 1/ US$/CHF Euro interest Interest EMU 8/2011 1/2015 Exchange Euro/CHF 01 Jan Jan Jan Jan Jan Jan Jan Jan 16 Japanese interest Interest Japan 8/2011 1/2015 Exchange Yen/CHF British interest Interest United Kingdom 8/2011 1/2015 Exchange GBP/CHF 01 Jan Jan Jan Jan Jan Jan Jan Jan 16 Negative Nominal Interest Rates and Exchange Rates 8

9 Little Linkage Between EER Volatility and Interest Rate Level Measure volatility as standard deviation (over month) of firstdifferences of natural logarithms No relationship between exchange rate volatilityand interest rate level Even for negative nominal interest rates! Negative Nominal Interest Rates and Exchange Rates 9

10 Effective Exchange Rate Volatility and Interest Rates: Switzerland Switzerland Monthly observations Exchange rate volatility /2015 9/2011 8/2011 Slope=-.18 (.15) Interest rate Standard deviation of change in daily log effective exchange rate (%); 30-day annualized interest rate Negative Nominal Interest Rates and Exchange Rates 10

11 Also True of Other Currencies US $, Euro, Yen, Pound Sterling, Danish Krone, Swedish Krone 4 more currencies with NIRP Still no strong linkage between exchange rate volatility and interest rate level Some signs of positive linkage Nothing unusual when nominal interest rate becomes negative! Negative Nominal Interest Rates and Exchange Rates 11

12 Effective Exchange Rate Volatility and Interest Rates: Others Exchange Rate Volatility and Interest Rates Monthly observations Exchange rate volatility United States Slope=.62 (.18) EMU Slope=.08 (.03) Denmark Slope=-.01 (.01) Exchange rate volatility Japan Slope=.80 (.51) United Kingdom Slope=.02 (.17) Sweden Slope=.03 (.01) Interest rate Interest rate Interest rate Standard deviation of change in daily log effective exchange rate (%); 30-day annualized interest rate Negative Nominal Interest Rates and Exchange Rates 12

13 Econometric Verification Regress effective exchange rate volatility against interest rate level and dummy for NIRP 11 economies with effective rates (Australia, Canada, Denmark, Euro, Japan, New Zealand, Norway, Sweden, Switzerland, UK, and USA) 5 have NIRP (Denmark, Euro, Japan, Sweden, Switzerland) Include country-specific FE σ(eff i,τ ) = α + βinterest,τ + γnegdummy i,τ + ξ i,τ NegDummy i,τ is 1 if i has negative nominal interest rate at time τ, 0 ow Negative Nominal Interest Rates and Exchange Rates 13

14 Regressions of Effective Exchange Rate Volatility on Interest Rates Interest Rate Level Default.90 (1.52) Dummy, Negative Interest Rate 1.22 (2.78) Obs. 869 Negative Nominal Interest Rates and Exchange Rates 14

15 Sensitivity Analysis Interest Rate Level Dummy, Negative Interest Rate Observations Add Time FE (1.50) Without Country 4.54** FE (.58) Official (not market) 2.70 interest rates (1.62) (10.9) ** (3.19) (16.7) (5.52) (15.53) Without -.88 Fixers (1.63) Only lowest half by interest rate (7.16) Without > 2σ.56 Outliers (1.08) (2.52) -12.9** 869 (3.1) 7.35* 869 (3.01) n/a (4.37) 3.12 (7.42) (5.66) (23.29).39 (3.34) (4.40) 1.53 (1.92) Negative Nominal Interest Rates and Exchange Rates

16 True in Bilateral Rates too Russia only exception to insignificant slope But minimal Russia interest rate >3% (average >7%) No sign that negative nominal rates matter Negative Nominal Interest Rates and Exchange Rates 16

17 Bilateral Exchange Rate Volatility and Interest Rates Bilateral Exchange Rate Volatility and Interest Rates Monthly observations Australia China India Volatility / / / Indonesia Korea Pakistan Volatility / / / Russia Taiwan Turkey Volatility /2014 1/ / / National interest rate National interest rate National interest rate Standard deviation of change in daily log bilateral Swiss exchange rate (%); 30-day annualized interest rate Negative Nominal Interest Rates and Exchange Rates 17

18 Quick Summary Little evidence that negative nominal interest rates have affected exchange rate volatility But NIRP sometimes prompted by concerns about level of exchange rate (Denmark, Switzerland) Now move from second- to first-moment of exchange rate Negative Nominal Interest Rates and Exchange Rates 18

19 Uncovered Interest Parity Well-known: UIP fails badly in literature Often ex post changes in exchange ratesnegativelycorrelated with forward premium! Does the UIP relationship change in the presence of negative nominal interest rates? Essentially compare ex postone-month change in bilateral Swiss exchange rate to forward premium Negative Nominal Interest Rates and Exchange Rates 19

20 What Does the Data Say? Pooling entails muchdependency across Time (prediction horizon > data frequency) handle with monthly data Countries (cross-sectional dependency) handle with care! Little sign of any strong positive relationship But slope is positive, bothfor a) whole sample; b) observations with one negative interest rate (half of sample) Negative Nominal Interest Rates and Exchange Rates 20

21 Monthly Exchange Rate Changes and Forward Premia One-Month Exchange Rate Change and Forward Premia Monthly Observations Exchange Rate Change Whole Sample (4492 obs) Slope=.39 (.18) One Negative Interest Rate (2084 obs) Slope=.56 (.19) Exchange Rate Change Positive Interest Rates (2354 obs) Slope=-.10 (.23) Forward Premium Two Negative Interest Rates (15 obs) Slope=31 (18) Forward Premium 60 currencies/swiss Franc, 1/2010-5/2016, without Argentina 11/2015 Negative Nominal Interest Rates and Exchange Rates 21

22 Positive Results Warrant Further Investigation Zoom into periods of different Swiss interest rates Histogram suggests: a) periods of very negative rates; and b) periods 0 Swiss interest rates very negative(<-.5%): no relationship Swiss interest rates tiny positive (<.1%): no relationship Swiss interest rates tiny negative (>-.1%): positive relationship Statistically significant but poor fit, few observations Statistically different slope as interest rates positive/negative Negative Nominal Interest Rates and Exchange Rates 22

23 Monthly Exchange Rate Changes and Forward Premia: Zooming In Exchange Rates during Small/Negative Interest Rates One-Month Exchange Rate Changes and Forward Premia Density Histogram Swiss Interest Rate Exchange rate change Tiny Positive Interest Swiss interest (0,.1%) Slope=.08 (.22) Forward premium Exchange rate change Negative Interest Rate Swiss interest <-.5% Slope=.43 (.25) Forward premium Exchange rate change Tiny Negative Interest Swiss interest (-.1%,0) Slope=.93 (.20) Forward premium Monthly observations for 60 currencies/swiss Franc, 1/2010-5/2016, without Argentina 11/2015 Negative Nominal Interest Rates and Exchange Rates 23

24 Even More Investigation Switch to Euro; manymore observations with interest rates close to zero (both positive and negative) Euro interest rates miniscule positive (<.05%): negative relationship Euro interest rates miniscule negative (>-.05%): no relationship Quite different from Swiss Franc (none/significantly positive) Statistical analogue to come Negative Nominal Interest Rates and Exchange Rates 24

25 Monthly Exchange Rate Changes and Forward Premia: Zooming Into the Euro Exchange Rates with Similar/Dissimilar Interest Rates One-Month Exchange Rate Change and Forward Premia Positive Euro interest >=1.25%, 236 Obs Slope=.17 (.87) Exchange Rate Change Miniscule Positive Euro interest [0,.05%], 231 Obs Slope=-.13 (.01) Negative Euro interest <=-.25%, 114 Obs Slope=-.69 (1.16) Forward premium Exchange Rate Change Miniscule Negative Euro interest [-.05%,0), 171 Obs Slope=.35 (.19) Forward premium Monthly observations for 60 currencies/euro, without Argentina 11/2015 Negative Nominal Interest Rates and Exchange Rates 25

26 Testing UIP Estimate: log(s i,t+21 )-log(s i,t ) = α + β[log(f i,t+21,t )-log(s i,t )] + γone i,t + δboth i,t + ε i,t+21,t Notes: No risk premium, rational expectations, large sample: α=0, β=1, γ=δ=0 Much of literature has β<1 (often negative) MA errors, so use Newey-West standard errors Negative Nominal Interest Rates and Exchange Rates 26

27 Fama Regressions: NIRP as intercept Slope Intercept One Negative Interest Rate Two Negative Interest Rates Observations Prevalence 50% 49% 1% 93,937 Common Intercept.59** (.12).16** (.06) 93,937 Default.58** (.13).13* (.07).07 (.08) -.57** (.16) 93,937 Country FE.61** (.16) n/a.10 (.08) -.87** (.20) 93,937 Negative Nominal Interest Rates and Exchange Rates 27

28 Results UIP works poorly: easily reject α=0, β=1 Doesn t change with NIRP dummies Results robust to robustness checks ButUIP works better than usual (β>0) Can also check if slopes vary by NIRP (multiplicative, not additive) Negative Nominal Interest Rates and Exchange Rates 28

29 Size of Euro Interest rate Testing for Slope Discontinuity of Fama Regression Euro Interest Rate Positive Negative Equality Test (p-value) Observations In +/-.05%.25 (.32) -.19 (.20) 1.5 (.22) 9,526 In +/-.10%.76 (.45) -.23 (.16) 1.3 (.25) 37,742 In +/-.15%.42 (.27).27 (.16).3 (.62) 42,919 In +/-.20%.77 (.11).37 (.17) 4.2* (.04) 47,188 In +/-.25%.75 (.11).47 (.17) 2.0 (.16) 54,689 Negative Nominal Interest Rates and Exchange Rates 29

30 Another Approach: Carry Trade Returns Carry trade relies on UIP deviations Consensus in literature of positive but risky returns (Burnside et al) We ask Do carry trade returns vary with negative nominal interest rates? Negative Nominal Interest Rates and Exchange Rates 30

31 Constructing Carry Trade Returns 1. Begin with Swiss Franc as default currency to measure cumulative returns. Also use Pound Sterling and American dollar for sensitivity 2. Each month, sort all 60 currencies (excluding base) by interest rate Use interest rates implied by CIP through forward premium Also use explicit interest rates 3. Form two portfolios Short portfolio with lowest three interest rates (equally weighted) Long portfolio with highest three interest rates Also consider portfolios with five and ten currencies 4. Construct returns for (long, short and) long minus short portfolios 5. Each month, repeat steps 2-4 Negative Nominal Interest Rates and Exchange Rates 31

32 Carry Trade Returns Flow and Cumulative Excess Returns Returns from long-short strategies in 3 base currencies (# currencies/portfolio) Flow returns Swiss Franc, (3) Jan 10 Jan 12 Jan 14 Jan 16 Swiss Franc, (5) Jan 10 Jan 12 Jan 14 Jan 16 Swiss Franc, (10) Jan 10 Jan 12 Jan 14 Jan 16 Cumulative returns Flowreturns Pound Sterling, (3) Jan 10 Jan 12 Jan 14 Jan 16 Pound Sterling, (5) Jan 10 Jan 12 Jan 14 Jan 16 Pound Sterling, (10) Jan 10 Jan 12 Jan 14 Jan 16 Cumulative returns American Dollar, (3) Flow returns Jan 10 Jan 12 Jan 14 Jan 16 American Dollar, (5) Jan 10 Jan 12 Jan 14 Jan 16 American Dollar, (10) Jan 10 Jan 12 Jan 14 Jan 16 Cumulative returns Flow/cumulative returns: thin/thick, solid/dashed line, left/right axis. Implicit interest rates. Negative Nominal Interest Rates and Exchange Rates 32

33 Using Explicit Interest Rates Flow and Cumulative Excess Returns Returns from long-short strategies in 3 base currencies (# currencies/portfolio) Excess returns Swiss Franc, (3) Jan 10 Jan 12 Jan 14 Jan 16 Swiss Franc, (5) Jan 10 Jan 12 Jan 14 Jan 16 Swiss Franc, (10) Jan 10 Jan 12 Jan 14 Jan 16 Cumulative returns Excess returns Pound Sterling, (3) Jan 10 Jan 12 Jan 14 Jan 16 Pound Sterling, (5) Jan 10 Jan 12 Jan 14 Jan 16 Pound Sterling, (10) Jan 10 Jan 12 Jan 14 Jan 16 Cumulative returns Excess returns American Dollar, (3) Jan 10 Jan 12 Jan 14 Jan 16 American Dollar, (5) Jan 10 Jan 12 Jan 14 Jan 16 American Dollar, (10) Jan 10 Jan 12 Jan 14 Jan 16 Cumulative returns % Flow/cumulative returns: thin/thick, solid/dashed line, left/right axis. LIBOR/Euro/National interest rates. Negative Nominal Interest Rates and Exchange Rates 33

34 Carry Trade Returns Pervasive but risky Higher with fewer currencies in portfolios But do returns vary with NIRP? Estimate: CARRY c,s,i,t = α + βneg t + ε c,s,i,t CARRY c,s,i,t monthly flow carry-trade return measured in currency c, with s currencies in both long/short portfolios, using measure i of interest rates (implicit in forward rates/explicit) at month t, NEG t importance of negative interest rates at t(any? number?) Negative Nominal Interest Rates and Exchange Rates 34

35 Returns from Long-Short Portfolios and Negative Interest Rates Currency Portfolio Size Interest Rates Number of Negative Interest Rate Swiss Franc 3 Implicit.002 (.002) Swiss Franc 5 Implicit.001 (.001) Swiss Franc 10 Implicit.000 (.001) Pound Sterling 3 Implicit.002 (.002) American Dollar 3 Implicit.002 (.002) Swiss Franc 3 National (.002) Any Negative Interest Rates.006 (.007).007 (.006).002 (.004).007 (.007).006 (.007) (.007) Negative Nominal Interest Rates and Exchange Rates 35

36 Negative Results No evidence that carry trade returns depend on negative nominal interest rates Negative Nominal Interest Rates and Exchange Rates 36

37 Conclusion No evidence of strong effects of NIRP on exchange rate behavior Volatility unaffected by level of interest rates, especially around 0 UIP works better recently, but no differences around 0 interest rates Carry trade returns unaffected Caveat: have ignored most consequences of NIRP Growth, inflation Bank profitability, micro-structural effects Financial Stability Another caveat: limited sample Only 5 economies for limited period of time Negative Nominal Interest Rates and Exchange Rates 37