Emerging Markets Currency Factors and U.S. High Frequency Economic Shocks

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Relying on the structural vector autoregression developed by Cieslak and Pang (2021), we identify four shocks to the U.S. economy based on the U.S. Treasury yield curve and the stock market: two fundamental news shocks (growth and monetary policy) and two risk-premium shocks (common and hedging). We find that these shocks explain over 40% of the time-series variation of emerging markets currency (EMFX) returns. Additionally, EMFX returns increase significantly with positive U.S. growth shocks and decrease with monetary tightening and risk-premium shocks. We then build long-short currency portfolios based on several academically researched style factors and test their relative exposure to U.S. macroeconomic shocks. We find that only Carry and Macro Momentum long-short portfolios generate positive and significant alphas and excess returns over our sample. However, all single factor portfolios have sizable exposure to U.S. high-frequency shocks. We show that a simple multifactor approach to investing in EMFXs eliminates the exposure of excess returns to U.S. macroeconomic shocks.