Balance of Trade Announcements and Movements in Exchange Rates

Abstract

There is a growing literature on the effect of on foreign exchange rates. The effects of weekly money supply announcements on exchange rates have been empirically investigated by a number of researchers over a variety of periods [1; 2; 3; 4; 7; 11; 12; 13]. The response of foreign exchange rates to other types of economic information has also been studied. For example, Dornbusch [5] uses innovations in the current account, cyclical factors, and interest rates; Frenkel [10] uses innovations in interest rate differentials; Edwards [6] uses innovations in money, real output, and real interest rates. Most recently, Hardouvelis [14] studies the market response of three interest rates and seven exchange rates to economic news on fifteen economic aggregates, including monetary announcements, inflation rate announcements and announcements reflecting the stage of the business cycle. This paper studies short run movements in foreign exchange rates to the Commerce Department's monthly announcements of the U.S. Balance of Merchandise Trade. It extends previous studies of foreign exchange response to economic news in three ways. First, by studying the response to the trade announcement, which occurs two months after the month to which the announcement refers, the paper provides a more precise measure of the response to the news content of trade-related announcements than earlier studies. This, for instance, is an improvement over Dornbusch's [5] definition of current account news as the innovation in the actual OECD (Organization for Economic Co-operation and Development) biannual current account estimates. Second, the paper studies not only movements in spot rates to the announcement, but calculates the movements in forward premiums to this information. By studying the response in forward premiums to the merchandise trade announcements, the paper examines whether the information in the announcements implies effects that operate through capital flows and interest rates in addition to responses that operate through the flow of merchandise trade.