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Exchange rates and the yield curve

Author

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  • Stavrakeva, Vania

    () (London Business School)

  • Tang, Jenny

    () (Federal Reserve Bank of Boston)

Abstract

In this paper, we confront the data with the financial markets folk wisdom that an increase in a yield or forward rate of country i relative to j is associated with a contemporaneous appreciation of currency i. We find that while the folk wisdom prior to 2009:Q1 holds fairly well for all maturities and three major currency bases, the “coefficient curve” twisted during the zero-lower-bound period so that the relationship became stronger at the short end but weaker and even of the opposite sign at the long end of the curve. We attribute the structural breaks at the short end of the curve to a change in the relationship between expected excess currency returns and changes in relative yields/forwards. The breaks at the long end of the curve can be explained by changing relationships between yields/forwards and the part of exchange rate fluctuations due to changes in expectations over future short-term rates and long-run relative price levels. Alternatively, the twist of the coefficient curve can be attributed to the changing relationship between the exchange rate and the expectation hypothesis component of yields/forwards at the short end and the term premium component at the long end.

Suggested Citation

  • Stavrakeva, Vania & Tang, Jenny, 2016. "Exchange rates and the yield curve," Working Papers 16-21, Federal Reserve Bank of Boston.
  • Handle: RePEc:fip:fedbwp:16-21
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    References listed on IDEAS

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    Cited by:

    1. Brainard, Lael, 2017. "Cross-Border Spillovers of Balance Sheet Normalization : a speech at the National Bureau of Economic Research’s Monetary Economics Summer Institute, New York, New York, July 13, 2017," Speech 964, Board of Governors of the Federal Reserve System (U.S.).
    2. Brainard, Lael, 2017. "Cross-Border Spillovers of Balance Sheet Normalization : a speech at "Normalizing Central Banks' Balance Sheets: What Is the New Normal?" a conference sponsored by Columbia University’s Scho," Speech 963, Board of Governors of the Federal Reserve System (U.S.).
    3. Forti Grazzini, Caterina & Rieth, Malte, 2017. "Interest Rates and Exchange Rates in Normal and Crisis Times," Annual Conference 2017 (Vienna): Alternative Structures for Money and Banking 168281, Verein für Socialpolitik / German Economic Association.

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    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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