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What Volatility Reveals: Agnostic Identification of Exchange Rate and Treasury-Market Dynamics in Inconvenient Times

Author

Listed:
  • Lucas ter Steege

    (Deutsche Bundesbank)

  • Sofia Velasco

    (Banco de España)

Abstract

This paper studies the financial-market transmission of the April 2025 U.S. tariff announcements, with a particular focus on the unusual combination of dollar depreciation and rising long-term U.S. Treasury yields. We ask whether the market reaction can be understood as the propagation of a single tariff-announcement shock or whether it instead reflects the interaction of distinct macro-financial disturbances. To address this question, we exploit time variation in the volatility and excess kurtosis of structural shocks to recover macro-financial forces without imposing event-based restrictions or exclusion assumptions. Our results show that the initial market reaction is consistent with a conventional safe-haven shock, but this mechanism cannot account for the subsequent joint behaviour of exchange rates and long-term U.S. Treasury yields. Instead, different segments of financial markets are dominated by distinct orthogonal shocks associated with safe-haven demand, confidence in U.S. institutions, Treasury-market intermediation and changes in the convenience value of dollar-denominated safe assets.

Suggested Citation

  • Lucas ter Steege & Sofia Velasco, 2026. "What Volatility Reveals: Agnostic Identification of Exchange Rate and Treasury-Market Dynamics in Inconvenient Times," Working Papers 2629, Banco de España.
    • Handle: RePEc:bde:wpaper:2629e
    DOI: https://doi.org/10.53479/44413
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    References listed on IDEAS

    as
    1. Waggoner, Daniel F. & Zha, Tao, 2003. "A Gibbs sampler for structural vector autoregressions," Journal of Economic Dynamics and Control, Elsevier, vol. 28(2), pages 349-366, November.
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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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