William D. MacMillan

FOREX Investing: Central Bank Sentiment Data across the Globe

With command over the Treasury’s dollar production (which are called Federal Reserve Notes) and interest rates, the Fed directly influences both the quantity and price of money more than any other actor. Given its central role in upholding the integrity of the currency, it makes sense to regard the central bank’s words not only as authoritative assessments of the state of the dollar, but also as catalysts for market movement themselves. As sensible as this deduction seems, it is surprising to note how little this connection has been researched. Although numerous scholars—especially since the financial crisis—have evaluated the role of central bank communications in the financial markets and the effect of those communications on currencies, money itself, as noted German economist Marcel Fratzscher explains, has yet to be widely explored: While there is broad agreement that actual [foreign exchange] purchases or sales may affect exchange rates under certain conditions […], hardly any work has been done on the issue of whether oral interventions may be effective, apart from [Jansen and de Haan’s work] and [Fratzscher’s work]. (Fratzscher 2008, 1652)

ECB Sentiment: Decoding a Complex Monetary Union

Transparency, and the implications it has for those who study the world of finance, is the central thread of this book. From the origin of the Fed to the financial crisis and beyond, the last two parts have tackled the development of this central banking strategy, discussing the attempts that others and we have made to interpret the wealth of text that now flows from the Federal Reserve. But, as has been discussed in early chapters, transparency is a trend that far exceeds American borders. Although the first experiments in central banking transparency were the product of the Volcker era, transparency began in earnest overseas, when, in the mid-1980s, the Bank of England began issuing press releases. In short, transparency has been an international movement for several decades. Part III of this book examines the state of this global phenomenon—an account that begins with Europe’s leviathan, the European Central Bank (ECB).

RBA Sentiment: Australia as a Proxy for China

This book, so far, has covered the Federal Reserve, the European Central Bank, the Bank of England, and the Bank of Japan. The economies these banks preside over all fall within the top five worldwide and, consequently, their significance to the global market is obvious. Sitting at 13th, the Australian economy has pull, but it still lags far behind the production power of the European Union, the United States, the United Kingdom, and Japan (Economy Watch 2010). With this in mind, at least one question immediately arises: why examine the Reserve Bank of Australia (RBA) alongside these other central banks when seven other, larger economies stand in line between Australia and this group? The answer lies in Australia’s close ties to a market that shares the thin air occupied by that cadre of heavy-hitters: China. Beginning with a short history of the RBA, this chapter explores the relationship between the Australian and Chinese economies, highlighting how a close examination of RBA communications could provide valuable insight into two of the most powerful economies in the world.

Independence: Wars, Depression, and Politics

The executive branch dominated the Fed through the 1940 and early 1950s. Although Congress held sway over the board of directors and the Fed’s relative independence mitigated the White House’s supremacy, the executive branch’s inevitable control sprung from the institutional design of the Fed—and the power of a unitary executive. The Treasury provided the muscle behind this control, and decades of conflict between Fed officials and Treasury officials provided the political fires that forged the development of today’s independent and transparent reserve system. This chapter continues the account of the political battles, financial reforms, and world wars that fostered the Fed through the Great Depression to their independence and beyond.

Data-Driven Fed Watching: Comprehensive, Unbiased, and Quantitative

The days of an unknowable Fed are over. Advisors, financiers, and financial professionals of all levels no longer need to speculate about the width of a briefcase or spend valuable hours teasing apart elusive—or perhaps nonexistent—kernels of policy embedded in Fedspeak. The Fed has embraced transparency, and the financial world is better for it. But, the abundance of central banking data now available to financial professionals does not do much good unless accompanied by effective analysis. Current Fed watching certainly supplies abundant analysis—and has even created a rigorous approach to press release interpretation—but the overall effectiveness of this methodology is questionable in a world where central banks use multiple important lines of cornmunication. Even at their best, modern methods provide projections based on qualitative opinions—not quantitative data—when identifying the Fed’s current policy position. Current Fed watching techniques simply do not provide the strongest analysis of the Fed’s outlook and future policy for financial professionals. If an accurate assessment of central bank communication is important to understanding the market—and it undoubtedly is—analysts ought to stop treating central bank communications like poetry when attempting to zero in on policy: “close reading” may be great for unlocking Shakespeare’s sonnets, but it’s not the best method of understanding essential, market-moving data.

Equity Market Investing: Macro Matters

The connection between central bank policy and fixed-income markets is clear, but the Fed’s actions and words also find traction outside of bonds and bills. Equity markets, just like fixed income, also react to Fed communications. As Marcel Fratzscher, the former head of policy analysis at the European Central Bank, and Michael Ehrmann, the head of economic and financial research at Bank of Canada, have asserted, “Central bank communication is a statistically and economically important driver of financial markets” (Ehrmann and Fratzscher 2007). Economists and financial professionals have observed the budding ties between central bank dispatches and the equity markets in recent years, and our work integrating textual analysis with market reaction sheds additional light on this trend. Diving into the world of equities, this chapter explains the fundamentals underpinning equity markets. After covering the essentials, it then highlights the deep connections that have developed between central banks and equity movements—and the reasons behind this growing relationship. Finally, this chapter investigates the application of our central banking data to this space, demonstrating how our methodology could provide deeper insight into the ebb and flow of the modern equity markets.

Global Sentiment: International Central Bank Transparency

The Federal Reserve. The European Central Bank. The Bank of England. The Bank of Japan. The Reserve Bank of Australia. The People’s Bank of China. Exploring their history, politics, and processes, this book has tackled this influential group to assess the development of transparency within central banking’s most significant institutions. This is not to diminish the power of other central banks. All central banks have tremendous economic sway—if not globally, domestically—and consequently merit the attention of those who wish to have a grasp on the financial world. In light of this necessity, this chapter picks up where the last four left off, concisely cataloguing the background and current strategies of a host of additional institutions. This chapter does not cover every central bank in the world; there are over a hundred. Instead, we review a selection of institutions that represent the three general categories that central banks fall into globally: banks in developed countries that are transparent, banks in developed countries that have yet to firmly embrace transparency, and, banks, regardless of transparency, of emerging national economies. An integral element of this account will be our sentiment data and the bearing it has on each of the economies these banks preside over.

Fixed-Income Investing: Fed Sentiment Drives Bonds

The Fed and fixed-income investments have a long history: buying and selling bonds and bills to maintain the price of money is a traditional domain of the Fed. Through wars and financial crises, the central bank and this market have forged a deep connection, and, with this history, it’s no wonder that when the Fed speaks its words ripple across the fixed-income markets.

Transparency: Data Meets Democracy

Like the 1950s and 1960s, the Fed’s next era had its own defining leader: Paul Volker. Martin had shaped the Fed into a more centralized, powerful, and modern machine, and when Volker arrived on the scene—after two lackluster chairmen came and went—he would continue that tradition. Under his guidance, the Fed would continue its march from democracy to technocracy. This transformation would measurably increase the central bank’s effectiveness, but it would also obscure its processes and the motivations behind its policy. As the previous chapter briefly mentioned, this opacity—this mixture of complex bureaucracy, complex processes, and complex data—made improving the lines of communication between the Fed and the government and the public an absolute necessity. What the Fed eventually grew to understand was the necessity of transparency, but that understanding would not be easily earned.

BOJ Sentiment: Monetary Clues in Lost Decades

Japan and industry are almost synonymous. Home to Toyota, Mitsubishi, Honda, and Hitachi, Japan’s list of major companies seems almost endless. And so does the nation’s commitment to work: so many Japanese have died from their workload that the tragic circumstance has been given its own word. While the level of dedication shown by some of its workforce is almost unfathomable, what is very concrete is the country’s place in the global market: the tiny island nation is home to the world’s third largest national economy. As familiar as it may be today, Japan was certainly not always the economic powerhouse it is today. In a historic economic achievement that can, perhaps, only be described as miraculous, over hundred years ago, over the course of a handful of decades, Japan transformed its insular, fledgling market—one far outpaced by much of the developed world—into an undisputed engine of production.