22 March 2023 Asset Allocation | Fiscal Policy | US

Why Investors Should Not Ignore US Data

Summary

A new NBER working paper investigates the correlation between US macroeconomic data releases and foreign stock markets.
They find that US macro news explains 23% of the quarterly variation in foreign equity prices, 15% in the VIX, and 25% in commodity prices.
US monetary policy news is also important, with Fed statements roughly three times more influential in international equity prices than the ECB and BoE.
The US’s influence impacts global growth expectations and risk premia, with investors using the news to determine their risk positions.

Introduction

The economic conditions of most countries are somewhat intertwined. Few would argue against this, but where does the ripple that permeates its way through the global economy start?

A new NBER working paperargues that the US is a major cause of many global shocks, explaining roughly a quarter of foreign stock market variation around significant macroeconomic news events. It reaffirms the need for investors to stay abreast of data coming out of the US.

Interestingly, how US news affects foreign asset prices is unrelated to US monetary policy. It is the risk-taking behaviour of international investors responding to macroeconomic data that influences the global financial cycle.

A High-Frequency Study

The authors accurately assess the causal links between the US and the global financial cycle by using high-frequency data. In particular, they analyse the intraday effects of US macroeconomic news surprises, such as those associated with the nonfarm payroll employment release – published monthly by the Bureau of Labor Statistics (BLS).

The analysis covers 27 countries over 23 years (1996 to 2019) and looks at the movements of major stock indices in 30-minute windows around US macro news events (Table 1). They also look at the impacts on the Cboe Volatility Index (VIX) and other implied volatility measures, as well as commodity prices.

Naturally, other factors may influence the prices of stock markets during these 30-minute windows. A surprise in US nonfarm payrolls may coincide with a news event elsewhere. However, by focusing on small time windows and by looking at news ‘surprises’, that is, the difference between the actual and forecasted numbers, the chance of other global shocks muddying the water is smaller.

Just in case, though, the authors look at whether global events also influence US prices or whether US macro data surprises are more likely to reflect a global structural shock rather than a US-specific shock. They confidently rule out both.

US Macro News Dominates International Markets

First, the authors look at the average stock market impact around each macroeconomic news event for all countries (Chart 1). I will ignore interpreting the actual numbers because they are less intuitive, but the results show that positive surprises in most macroeconomic data lead to an increase in foreign equity prices in the 30-minute window around the release.

The largest increases come from positive real GDP and nonfarm payroll surprises, while higher-than-expected inflation prints typically hurt foreign stock markets. Foreshadowing later results, US data surprises appear to influence global investors’ risk appetite.

Next, the authors decompose the results by country (Chart 2). We can see a lot of country-level heterogeneity for the two events that spark the greatest stock price movements, GDP and nonfarm payrolls. Equity indices in Germany and France tend to react significantly to US news, while South American ones do not.

Interestingly, all equity indices tend to move in the same direction; US macro events lead to a correlated asset price response. According to the authors, this shows a clear correlation between the US and the global financial cycle.

Lastly, the authors review the impact of macroeconomic news surprises on the VIX, a widely used proxy of global uncertainty. Again, news shocks have a large impact, although capacity utilisation, Core Producer Price Index (PPI), and durable goods orders data releases do not have a clear correlation to movements in the VIX.

If You Do Not Trade Intraday

Even if you do not trade intraday, US data releases still have key information regarding the direction of stock prices (Chart 3). Positive news shocks can have large daily, monthly, and quarterly impacts on foreign equity indices. On average, US news explains 23% of the quarterly variation in foreign equity prices.

The same holds true for commodity markets and the VIX. At the quarterly frequency, US macroeconomic news explains typically between 15% and 25% of the variation in the implied volatility measures, as well as 25% in the commodity factor.

Unsurprisingly, similar news surprises in non-US countries do nothave an impact on US equities. According to the authors, these findings imply that the effects of US news on foreign markets predominantly reflect US-specific shocks, rather than shocks common to all countries.

What About FOMC Meetings?

A lot of research is done on the impact of the Federal Open Market Committee (FOMC) statements on markets. Here, the authors compare the price movements of international stocks after the Fed, the Bank of England (BoE), and the European Central Bank (ECB) meetings (Chart 4). The results again imply that US news (in this case, monetary policy) is more important for international markets than other countries.

An Insatiable Risk Appetite

The paper attempts to highlight the drivers of foreign equity price movements in the face of US data shocks. To do this, the authors decompose stock prices into a risk-free rate, equity risk premium, and a growth expectations component. They do the same for bond yields. Then, they compare the joint responses of bond yields and stock markets, both for the US and foreign markets.

They find that, while bond yields respond to US macroeconomic news, these responses cannot generally explain the observed changes in stock prices. Instead, the evidence suggests that US news affects stock prices predominantly through growth expectations or a risk premia.

Further digging shows the equity premium is quantitatively more important for stocks than expected future dividends. Moreover, after news revealing greater-than-expected economic activity, such as positive surprises in nonfarm payroll employment, the equity premium falls while the term premium rises.

Such news appears to induce a shift from less risky securities, such as bonds, to more risky securities, such as stocks.

The reaction of foreign equity prices to US news reflects changes in the risk appetite of international investors. According to the authors, it cannot be explained by systematic US monetary policy reactions to news.

Bottom Line

The results are unsurprising. The US plays a central position in the global financial system, so it is likely to influence foreign equity markets. What is interesting is the scale of its influence. US data announcements can explain up to a quarter of stock price movements outside of US markets. So, keeping an eye out for US data releases should help inform the direction of equity markets, regardless of the country you are in.