Do Economic Surprises Explain Returns of Stocks, Rates, or FX?
Bloomberg’s Macro Man tested the surprise indexes against changes in the three markets. What he found is ... surprising.
The economic cycle is an important driver of financial asset returns, yet in many ways the stately march of expansion and recession moves too slowly for traders and portfolio managers. After all, the swirl of perceptions about economic growth can exert a significant influence on market prices even when the economy itself is little changed. A popular way to derive a signal from the noise of high-frequency economic releases is via economic surpriseindexes, such as those published by Bloomberg and Citigroup Inc. But can economic surprises actually explain—let alone forecast—financial asset returns? I decided to take a look.
The rationale behind economic surprise indexes is a compelling one. When an economy is accelerating, the thinking goes, economic data will typically exceed expectations—which ought to lead to higher stock prices and market interest rates, and potentially also a stronger currency. A slowing economy will produce negative surprises, with the opposite impact on markets.