International Portfolio Positions

From Liberty Street Economics, titled,  Hedging Income Fluctuations with Foreign Currency Assets,

Our exercise shows that a move toward longer and larger positions in foreign currency cannot be explained if economic fluctuations are driven by supply shocks—that is, during periods when weaker activity is accompanied by higher inflation and so the stronger the policy commitment to offset the inflation, the stronger the domestic currency gets. Clearly, in this environment, having bonds denominated in foreign currencies is a bad hedge.

Instead, recent international portfolio positions data are consistent with a world in which the economic environment is often affected by demand shocks. It would then be rational for investors to hold foreign currency bonds because adverse shocks to demand are accompanied by lower interest rates and a weaker domestic currency. Moreover, the stronger the central banks’ commitment is to offsetting the effect of lower demand on inflation by decreasing interest rates, the larger is the likely depreciation, justifying longer positions in foreign currency.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s