How do FX market participants affect the forint exchange rate?
In our analysis, we describe and compare indicators regularly used in the course of money market monitoring, identifying the positions of FX market participants where co-movement with the forint exchange rate is most commonly observed. The correlation between the exchange rate and quantity indicators may be attributed on the one hand to the fact that market participants’ directly unobservable exchange rate expectations are reflected in transactions and positions. On the other hand, these indicators are also determined by factors that are less affected by participants’ expectations, or are linked to one-off liquidity shocks, yet they may affect the exchange rate through demand-supply effects. The exchange rate position of participants shifts in reaction to trading strategies described in the analysis (spot or swap FX conversions related to the purchase/sale of HUF-denominated instruments, taking or hedging of exchange rate exposure, balance of payments items, etc.), and the domestic banking sector, as a participant vis-a-vis the initiating party, must transfer this position to another participant if it does not wish to assume exchange rate exposure. The effect of taken up and transferred positions is also reflected in exchange rate changes; the degree of change is basically determined by the heterogeneity of expectations. Position changes of FX market participants allow us to derive their expectations related to fundamentals and hence changes in the expected risk premium. We attempt to identify changes in the risk premium in positions determined by participants’ expectations of with quantity indicators used in the course of money market monitoring. Among the individual sectors, it is primarily non-residents, as initiators of the transactions, that are the quickest to change their behaviour in response to changes in the risk perception of Hungary, while resident non-bank participants adjust through the intermediation of the domestic banking sector. We observed substantial co-movement with the exchange rate in relation to all indicators; significant correlation can be identified within the short-term dynamics. The reaction of the exchange rate is most sensitive to the adoption of speculative money market positions and least sensitive to changes in the indicator defined as the widest aggregate, which also includes derivative positions. The relationship between indicators and the exchange rate may change in reaction to shocks; instability over time and structural breaks in the relationship may provide information as to the nature and effect of the shocks. On the basis of our results, the adoption of a speculative long forint money market position by non-residents in the value of HUF 100 billion results in a 2.89 per cent appreciation of the exchange rate. This same coefficient is 1.42 per cent in relation to spot transactions and 1.15 per cent for the total forint position. In addition to the above, a bidirectional correlation is observed in relation to the forward stock of resident corporate participants: first, changes in the forward stock produce a tangible effect on the exchange rate, and second, changes in the exchange rate significantly affect companies’ hedging activity.
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