| Abstract: |
The failure to find fundamentals that co-move with exchange rates or
forecasting models with even mild predictive power â?? facts broadly referred
to as "exchange rate disconnect" â?? stands among the most disappointing, but
robust, facts in all of international macroeconomics. In this paper, we
demonstrate that U.S. purchases of foreign bonds, which did not co-move with
exchange rates prior to 2007, have provided significant in-sample, and even
some out-of-sample, explanatory power for currencies since then. We show that
several proxies for global risk factors also start to co-move strongly with
the dollar and with U.S. purchases of foreign bonds around 2007, suggesting
that risk plays a key role in this finding. We use security-level data on U.S.
portfolios to demonstrate that the reconnect of U.S. foreign bond purchases to
exchange rates is largely driven by investment in dollar-denominated assets
rather than by foreign currency exposure alone. Our results support the
narrative emerging from an active recent literature that the US dollar's role
as an international and safe-haven currency has surged since the global
financial crisis. |