The 2024 elections bring to the global stage a new set of policymakers at a crucial moment for the global economy. Among other things, the new leadership coincides with increasing pressure on the global role of the U.S. dollar. FX market volatility could easily increase in 2025.
Global macro investors and investment advisors need stronger tools today to help them monitor, measure, and manage exposure to currency risks across a range of time horizons on order to maximize alpha generation and implement efficient smart beta strategies.
Their challenge: Policy risks that impact FX markets are expressed verbally but they need to measure risk quantitatively.
PolicyScope data meets this need with quantitative time series data and signals derived directly from official sector language. Our patented process provides markets with the capacity to measure momentum and volatility, accelerating the discovery of immediate opportunities and longer-term trends important to their portfolio thesis and structure.
This blogpost (Global Macro Use Case: Measuring Reserve Currency Policy Risk) provides perspective on how to pair PolicyScope data derived from public policy language with traditional economic data in order to support faster, more efficient trend projection. Specifically:
First, we set the stage with the policy and market context.
Second, we recommend three economic datapoints to pair with PolicyScope data.
Finally, we provide three concrete use cases for how the combined data sets can be used to support immediate trading, medium-term strategy, and market research initiatives.
The Policy and Market Context
Global reliance on the USD will not disappear overnight, if ever. But the trend towards currency diversification, particularly in pricing commodities and cross-border payments, sets the stage for potentially severe market reaction functions in the near-term.
Consider the policy and market landscape;
Newly elected policymakers throughout advanced economies (not just the United States) will seek to implement electoral promises quickly during 2025-26. Given the dispersion of electoral outcomes in France, Germany, the UK, Japan, and the United States during 2024, their policy priorities seem likely to conflict at least initially.
Geopolitical risks and increasingly violent conflicts continue to intensify. The resulting trade fragmentation will generate substantial economic realignments in addition to increasing the volume, velocity and volatility of the news cycle that drives headline risk and market volatility.
Policymakers in Europe seeking to increase their "strategic autonomy" see a digital euro as a mechanism to decrease reliance on the U.S. dollar although internal disagreements are slowing its progress..
For decades, many have expressed concern about the "weaponization of the dollar," as illustrated by this London School of Economics paper from 2019, this in 2022 blogpost from the Atlantic Council and this October 2024 research note from JP Morgan.
Federal Reserve balance sheet normalization is broadly expected to shift supply and demand dynamics for U.S. Treasury securities just as a growing number of commentators fret about the prospects for De-Dollarization.
Increased use of digital currencies in the real economy provides additional diversification options away from the USD either in the form of a cryptocurrency or a central bank digital currency.
The daily, tickerized notional volume measurements generated by the patented PolicyScope process provides strategists and portfolio managers with a precision instrument to spot even subtle policy shifts across a range of technical and high-value policy initiatives.
But knowing that policy is on the move is only part of the equation for strategic positioning. We therefore provide to our customers suggested pairings for PolicyScope data in order to generate precise signals and alerts. Internal strategists and experts -- from advocates and market strategists to chief economists -- will typically add their own preferred economic indicators as well in order to generate a framework tuned specifically to the firm's strategy and time horizon.
Top Three Reserve Currency Data Points
We recommend that global macro strategists pair PolicyScope data with at least the following three economic data points in order to assess the strategic significance of any given policy initiative relative to the USD:
Long-Term Securities Held by Foreign Residents (US Treasury Department): Measures foreign demand for U.S. sovereign debt. Issued monthly, with a two-month lag. The most recent data is for September 2024:
You can access the full data set and methodological information from THIS PAGE on the U.S. Treasury Department website.
Currency Composition of Foreign Exchange Reserves (COFER)(International Monetary Fund): Observation data showing which currencies central banks hold as part of their official reserves. Issued semi-annually based on voluntary reporting from central banks around the world. The most recent data is for 1H2024.
You can access the full dataset and methodological information on THIS IMF WEBSITE PAGE.
The IMF argued in a recent blogpost that the totals can be misleading. They suggest that the data needs to be adjusted for USD appreciation. Their estimates with adjustments for both exchange rates and interest rates make the case for "stealth erosion" particularly in light of the dramatic increases in holdings of other currencies (Australian Dollar, Canadian Dollar, Chinese Yuan Renminbi, and other currencies").
Foreign Currency Credit to Non-Banks (Bank for International Settlements): Measures long-term confidence in foreign currencies by domestic borrowers both in fixed income and bank loan markets. The June 2024 BIS Quarterly Review performed a deep dive into various data sets. The output shows a dramatic increase in demand for USD-denominated credit peaking in 2020:
BIS: Foreign currency credit to non-banks You can access all BIS International Banking Statistics on THIS BIS WEBSITE Page.
Any of these data points provide a solid foundation for evaluating the relevance of articulated policy shifts as measured by the patented PolicyScope process.
PRO TIP: Note that the official sector data does not include cryptocurrency transaction volumes. If you really want to measure migration to USD alternatives, it would be wise also to include in your economic data transaction volumes regarding the top five cryptocurrencies and stablecoins as well as official payment system data.
Three specific use cases (active/immediate FX trading; medium-term investment advisory; long-term trend projection) appear below for your consideration.
Global Macro Use Cases: Measuring Reserve Currency Policy Risk
using PolicyScope Data + Economic Data
Use Case 1 -- Inflection Point Trading Alerts
User Profile: Portfolio Manager (FX, Fixed Income)
Time Horizon: Immediate. The portfolio manager seeks information that is immediately actionable. NOTE: Backtests show that PolicyScope data consistently provides 24-26 hours advance notice of FX market volatility, particularly the USD/EUR cross rate.
Data Integration/Discovery Mechanism -- Pre-Set Alerts from PolicyScope Momentum Index: The Portfolio Manager configured internal systems to deliver automated alerts whenever the PolicyScope Momentum Index registers activity regarding a topic or issue important to the portfolio thesis or underlying structure. Options include:
Alert when a low frequency, high value topic has been raised. The example above is for GDP Growth, using data from 2Q2023.
Alert when the policy process registers sustained daily activity, which signals building momentum
Alert when the combination of PolicyScope measurements and a new economic data point occur. This requires the Portfolio Manager to have thought through in advance the likely impact of both the policy shift and the economic shift.
If the portfolio manager additionally uses a Generative AI interface to query the underlying official sector language, he or she can see the full context immediately without having to dig through various website pages and media coverage.
Outcome: Automated alerting accelerates informational advantage and alpha generation opportunities, enabling the portfolio manager to make a data-driven market decision based on concrete facts. Faster access to market-relevant information also generates operational efficiencies, making the trading process more efficient.
Use Case 2 -- Investment Advisory
User Profile: Investment Advisor to pension funds, foundations and high net worth individuals.
Time Horizon: 2-10 years. The Investment Advisor's clients hold large positions with holding periods measured in years and decades. They seek to "play through" market volatility and invest based on long-term trends and fundamentals.
Data Integration/Discovery Mechanism -- MACD Analysis: The Investment Advisor is responding to client questions concerning how current inflation policy will impact the dollar's global role and how to insulate the portfolio from potential losses associated with increased volatility. The Investment Advisor conducts a Moving Average Convergence Divergence (MACD) analysis on policy activity measured by the PolicyScope process and, in parallel, conducts the same MACD analysis for a currency. The data provides a baseline for the scale and velocity of policy activity regarding the issue during the selected period AND the related market reaction function. It also illuminates the timing and magnitude of market reaction functions. The investment advisor can then make recommendations and set alerts in case policy volatility and/or market volatility depart from the norm.
Outcome: Data-driven risk decisions and analysis that deliver independence from headline risk and metrics to evaluate when policy or market reaction functions depart from the norm.
Use Case 3 -- Investment Strategy and Research
PolicyScope Data: The pulse of public policy at your fingertips User Profile: Chief Economist | Fixed Income Analyst | FX Strategist | Global Macro Strategist
Time Horizon: 1 day to 10 years. The strategist regularly contributes analysis to portfolio managers, the C-suite, and Bloomberg/CNBC in addition to authoring long-form research notes that identify macro trends and their implications for investors.
Data Integration/Discovery Mechanism -- Dashboard/GenAI Interface:
The strategist centers a daily scan of horizon developments by spending 15-20 minutes every morning navigating dashboard charts and underlying content contributed by the PolicyScope process, which includes direct access to documents so that the strategist can spot all information in context.
When preparing long-form research notes, the strategist spends one hour navigating through historical data and documents within the dashboard which already contains structured quantitative momentum and language data.
If the firm has commissioned the Generative AI add-on, the strategist can additionally query the database in a conversational manner and receive back footnoted answers suitable for editing as well as discovery.
Outcome: Significant operational efficiencies. The strategist spends less time in hunter-gatherer mode hunting for relevant information. Instead, the relevant information has been automatically sourced, saved, and quantified by the PolicyScope process. The PolicyScope process dematerializes the global policy cycle and makes it accessible to strategists on their schedule, using a format and expert-crafted ontology that accelerates insight formation by literally making it easier to find strategic policy shifts even if those shifts were never reported by the media.
BCMstrategy, Inc. generates quantitative time series data and structured language data from public policy using a patented, award-winning process. Designed from the beginning to be used as ML/AI training data to support automated policy trend projection, the data is optimally structured to support deployment into automated research assistant applications powered by Generative AI. The company currently generates data within three thematic verticals: Monetary Policy (macroVS) | Climate/Energy Policy (CRRM3) | Digital Currency Policy (DCVS). More thematic verticals are planned for 2025.