More Hidden Treasures

It is not news that news moves financial markets. This blog will publish research on how, when, why, and which news moves what financial markets.

On Monday, November 06, 2006 in a post entitled “Recent Developments in How Economic Announcements Affect Financial Markets” I noted that the EUR and the CHF move in opposite directions when the U.S. trade news is announced. I expanded on this in the post on Wednesday, December 27, 2006, “Hidden Relationships”.

Here is another interesting discovery.

The Yen and the Pound appear, on average, to move in opposite directions to the U.S. Dollar when non-farm payrolls ("NFP") are announced. There may be some interesting profit maximizing strategies (or hedge opportunities depending on your perspective). Here is the chart of the historical relationship between the USD/JPY and GBP/USD (their 1-minute returns) after NFP announcements:

Vote for your favourite FX rate!

It is not news that news moves financial markets. This blog will publish research on how, when, why, and which news moves what financial markets.

Here is your chance to direct my research. Vote for your favourite FX rate!

Based on the preliminary research I have done, I am about to embark on a comprehensive research exercise to document the best models for the impact on financial markets of the following announcements:

1. U.S. Nonfarm Payroll
2. U.S. Initial Jobless Claims
3. U.S. Retail Sales (excludes autos)
4. U.S. Core CPI (excludes food and energy)

I will be, in time, covering all major financial markets. I am starting with exchange rates. This is your chance to vote for your favourite exchange rate. The most votes gets the most coverage in my blog.

Send an email to me at john.parker@yahoo.ca with your favourite currency pair in the title. So the U.S. Dollar to Euro exchange rate will be identified as “EURUSD”.

It will help in my compilation if you use the ISO 4217 currency codes with the base currency being the first currency in a currency pair. The second currency is the quote currency, counter currency or terms currency.

Market Expectations

It is not news that news moves financial markets. This blog will publish research on how, when, why, and which news moves what financial markets.

The best news depends on two factors:

1. The best measurement of the actual market move; and,
2. The best measurement of the market's expectation.

A market expectation based on information from derivative auctions outperforms survey measures.

Apart from proving more information the Economic Derivatives or market-based forecasts are found by Gürkaynak and Wolfers to outperform the survey data. They:

“… establish that the Economic Derivatives forecast dominates the survey forecast (although survey forecasts perform quite well) both in predicting outcomes and in predicting market responses to economic news.” (p. 13)

And,

· “… that central tendencies of market-based forecasts are very similar to, but more accurate than surveys. Further, financial market responses to data releases are also better captured by surprises measured with respect to market-based expectations than survey-based expectations, again suggesting that they better capture investor expectations. Some behavioral anomalies evident in survey-based expectations – such as forecastable forecast errors – are notably absent from market-based forecasts.” (p. 1)

The Federal Reserve Board of San Francisco (2006) (Wolfers) took data from the first 153 of these Economic Derivatives auctions and compared them with an alternative forecast aggregator: the survey of the expectations of financial market analysts taken on the Friday prior to the data release. They asked “which better predicts the actual data?” The Economic Derivatives forecasts were slightly (5%–10%) more accurate, although these differences were not statistically significant. They also found, more interestingly, once one knows the Economic Derivatives forecast, there is no useful information in the survey-based forecast.

They also analyze the change in stock and bond prices from 5 minutes before the announcement to 25 minutes later for the two alternative measures of news. In each case, they confirm that the Economic Derivatives market better predicts financial market responses to economic data than does the alternative survey-based measure.

Derivatives data was available for 7 series (now the CME only maintains 4) with the longest history going back monthly to September 2002. Survey data is available for some 170 series with the longest history going back weekly to 1980.

While the Economic Derivatives data is superior in terms of information content and usefulness for measuring the announcement effect, the survey data has a longer history and broader coverage. I use the economic derivatives data.

R-squared - Believe it or not!

It is not news that news moves financial markets. This blog will publish research on how, when, why, and which news moves what financial markets.

Most people are skeptical when I tell them that up to 80% of the variation in an exchange rate immediately after an announcement can be explained by news (defined as the actual release minus the market expectation derived from a derivatives auction for the announcement). A previous study using survey expectations data and a longer window around the announcement found R²’s of up to 25% (Faust, Jon, Rogers, John H., Wang, Shing-Yi B., Wright, Jonathan H., (2003) “The high-frequency response of exchange rates and interest rates to macroeconomic announcements” U.S. Board of Governors of the Federal Reserve System, International Finance Discussion Papers, number 784.)

By shrinking the window to a minute after the announcement and using derivatives-based expectations gives much bigger news impact coefficients and much higher R²’s. Comparing the size of the news impact with Faust et. al. (2003) the sign of the coefficients is the same (EUR/DM for Faust et. al., EUR for Parker and also GBP). Coefficients are larger as are the R²’s (with the exception of those for Retail Sales - which may suffer from a lack of expectations data as auctions were not held for a six month period between March and August 2004. The same may be the case for the GDP data in my study since there are only a few auctions to date). I attribute this to the more precise announcement window and the better expectations data.

Here’s an example Faust et, al. find the news coefficient for the International Trade Balance announcement on the EUR (DM) to be -10.09 with an R² of 0.24 ( Faust et. al. exchange rate returns are continuously compounded and multiplied by 10,000. The coefficient can be interpreted as the effect of a one unit surprise on the exchange rate in basis points.). I find that the coefficient is as significant (1% level) but the value is orders of magnitude bigger and the R² is 0.78.

Not only that but these results can be improved upon by adding other variables into the model.

Non Farm Payrolls - January 5th 2007

It is not news that news moves financial markets. This blog will publish research on how, when, why, and which news moves what financial markets.

Yesterday I reported that there seems to be lots of uncertainty leading up to tomorrow’s non-farm payroll announcement. Well, the numbers are in and Nonfarm employment increased by 167,000 in December.

Derivatives-based expectations had been declining for the last few days with the auction just before the announcement giving a market forecast of 77,9000. The market surveys were anticipating 100,000-115,000 but with some risk on the downside -" optimistic given the recent weakness in other jobs data" and"but this might prove to be tooa lot of people were looking for a nasty number because the ADP jobs report said the economy LOST 40,000 jobs." This sentiment was captured in the distribution of expectations:

My research suggests that the news that will drive the market this morning will be the 89,100 surprise (167,000 minus 77,900).

The uncertainity indicator information from the derivatives auction was correct - this one surprised the markets.

Caveat Emptor - Tomorrow's Dec. 2006 Non-Farm Payrolls Announcement

It is not news that news moves financial markets. This blog will publish research on how, when, why, and which news moves what financial markets. *** Updated 4:00pm EST at the close of the CME Economic Derivative auction ***

There seems to be lots of uncertainty leading up to tomorrow’s non-farm payroll announcement.

Below are the results from the economic derivative auctions that give the best market expectation for tomorrow. I have included in the table the time and date of the auction that gives the market expectation and the historical average from previous auctions:

The Employment Situation, December 2006 Changes in Non-farm Payrolls 8:30am Jan. 5 2007 Wednesday, January 3, 2007 Thursday, January 4, 2007 Thursday, January 4, 2008 Historical Average 8:00 AM EST 8:15 AM EST 4:00 PM EST Forward Price 112.73 87.35 85.38 Implied Distribution Statistics Mean 113.1 87.8 85.8 131.5 Volatility 290.7 315.3 318.2 87.5 Skew 0.0 0.3 0.3 0.6 Kurtosis -1.3 -1.2 -0.9 0.2

Notice that the mean forecast has moved from 113 to 85 since yesterday.

But look at the volatility. Yesterday it was 290, today it is 318 (3.6 times the average historical volatility of 87).

Here is the implied distribution from yesterday:

And here is the implied distribution from this morning:

And here is the implied distribution from this afternoon:

Look at the latest distribution. The calculated average (from the put and call prices) published on the CME website is 85.8 thousand jobs but the mode is for no growth in jobs (a derivative strike price of 0 jobs).

A dispersion in expectations means that there is more uncertainty than usual in the market. This could be good or bad depending on your perspective.

There is one more auction (7-8am) in advance of the release at 8:30am tomorrow. If you are interested, the link to the auction results is here.