Deficit financing announcements and asset prices

Abstract

There is a growing literature on the effect of economic news on asset prices. The effects of weekly money supply announcements on interest rates have been empirically investigated by a number of researchers over a variety of periods (Cornell 1982; 1983a; 1983b, Roley 1982; 1983, Roley and Walsh 1984, Urich and Wachtel 1984, Hein 1985, Gavin and Karamouzis 1986). The response of foreign exchange rates to new economic information has also been studied (Dornbush 1980, Frenkel 1981, Edwards 1982, Engle and Frankel 1984, Hardouvelis 1984, Hakkio and Pearce 1985, Culbertson and Koray 1986), while Cammack (1987) has studied the response to information in Treasury bill auction markets. Most recently, Wachtel and Young (1987) have studied the response of various interest rates to the Office of Management Budget and Congressional Budget Office projections of current and future Federal government deficits. Although a reading of the financial press would suggest that the Treasury's quarterly debt financing announcements are an important type of news for financial market participants, the examination of market responses to this type of news has not been investigated. The purpose of the present study is to investigate the financial market response to these announcements, and to relate these results to other studies of market response to economic news. The theoretical model underlying most of the existing news studies assumes that asset prices, including exchange rates, respond only to new information in an efficient market. The effect of this new information on prices is dependent on how the news changes financial market participants' expectations. This expectations effect can vary over time periods, since it is conditioned by market participants' recent experiences and the anticipated response of policymakers to economic news. This paper examines the shortrun responses of several major exchange rates and three types of domestic interest rates to the news implicit in the Treasury's quarterly announcements of new long-term debt issues over the period beginning in the third quarter of 1975 and ending in the third quarter of 1985. The time horizon is long enough to cover the majority of the recent period of floating exchange rates, as well as encompassing the period since the early 1980s, when the financial press became particularly concerned with the magnitude of the Federal deficit and its impact on financial markets. 1