Macro Uncertainty and Currency Premia

We study empirically the relation between currency excess returns and macro uncertainty, measured as forecast dispersion, on a wide set of economic indicators. We find that investment currencies deliver low returns whereas funding currencies offer a hedge when current account uncertainty is unexpectedly high. In contrast, uncertainty over other economic indicators displays a weak relation with the cross-section of currency returns. Moreover, an increase in current account uncertainty is associated with positive (negative) expected excess returns on investment (funding) currencies. This mechanism is consistent with the recent advances in exchange rate theory based on capital flows in imperfect financial markets