Monday, November 28, 2005

The peso's recent surge

Recently the dollar/peso exchange rate has been rising. To buy one hundred pesos, two months back you needed about 1.8 USD; these days you need about 1.85 USD. Why?

Government spindoctors have been crowing over improving confidence in the economy as the reason - with the immediate trigger being approval of the EVAT. Really? I don't know. But there is a real spike of OFW remittances, over and above the seasonality associated with Christmas. This spike is probably the result of a deeper structural change, related to supply and demand of Filipino OFWs. That is unrelated to the EVAT approval. In short, coincidence. Other sources of dollar inflow may be more sensitive to domestic policy changes. However all this is speculative.

A recent article in the Economist is a good reminder of how little we know about exchange rate movements: The currency market routinely confounds economists. A classic 1983 study by Richard Meese and Kenneth Rogoff, then both at the Federal Reserve, concluded that macroeconomic models could not explain a currency's direction of travel, let alone how far it would go. One would do just as well to assume that next month's exchange rate will be the same as this month's. After another 20 years of interrogation, the macroeconomic data has confessed little more of value.

One version of the "efficients markets" hypothesis is that exchange rates follow a random walk. What's a random walk? One simple form: the change in exchange rate is random. Models based on random walk are not inferior in predicting power than sophisticated models, say macroeconomic models, that take into account structural factors, such as purchasing power parity, differential interest rates, inflation, and so forth.

The reason perhaps is that traders' collective wisdom already incorporates these structural factors in their buying/selling decisions. What they cannot incorporate is "news" - which is random. (If it were non-random it could be predicted, and therefore not news!) The unpredictable nature of news - say those unforeseen shifts in supply and demand for OFW workers - is what introduces the random walk. On hindsight, we can perhaps tie in this particular exchange rate movement with that particular news - after considerable econometric torture. But that's only a way to get published - not rich.


Anonymous said...

This "surge" is really miniscule in my opinion, and if you take a longer term view, the Peso is still significantly down. One measure I use (non-scientifically) is the Peso-Baht rate, and we're still doing pretty bad.


Amadeo said...

I concur with the hypothesis that this peso surge may be due to the unusually large inward remittances coming from the OFWs.

Funny, though since on its own the US dollar is much improved vis-a-vis the other currencies, especially the Euro.

And the US stock markets are also on an upsurge. I personally would like to see the Dow break 11,000 before the year ends.

Amadeo said...

Additionally, at present I do not really know how the peso exchange rates are determined.

As I recall working for a local bank, forex exhange trading was done by CB with the BAP, with the CB pretty much calling whatever deficits were not accounted for during the daily tradings.

Econblogger said...


Deficits, you say? It must be in reference to maintaining some target exchange rate. For a fully floating exchange rate, deficits and surpluses are quickly eliminated by forex trade.

Anonymous said...

If you go to Yahoo Finance though, and look at the Peso-Dollar rate over 5 years, there is no surge in the December of the preceding 5 years (so we know it is not the "usual" remittances).

What would the explanation for "unusual" remittances be though?

As for the CB calling for deficits, I guess that means that it is a managed floating exchange rate? If so, what's the real impact of this? My sense is that the CB does not have enough reserves to manage the rate in case of big swings. If they are only stepping in during miniscule swings, in the big scheme of things, what's the point in doing so?


Amadeo said...

Observing the daily tradings then, at the end of the trading period, whatever remaining dollars being bought or sold by the local banks that were not accounted for or matched with, the CB simply bought or sold the required dollars to balance.

That was many years ago, but I believe the present floating rate method was already in place.