October 2023


Media narratives, flows and currency returns

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Whether it is a recession, trade wars or inflation, market narratives significantly influence institutional currency flows and returns, according to an analysis of economic and financial media-driven market narratives by Will Kinlaw, head of Research at State Street Global Markets, who co-authored the research with Zachary Crowell, Lee Ferridge, Michael Guidi, Gideon Ozik and Ronnie Sadka. 

Kinlaw demonstrated that by quantifying the impact of media narratives on currency prices, investors can better forecast returns alongside institutional flows, and thus make more informed decisions. 

“Currencies, like other investments, react strongly to changing media narratives — and these reactions are magnified when they are backed by institutional FX flows,” he said.

Relying on his analysis of more than 100 economic and financial narratives sourced from State Street’s MediaStats, an artificial intelligence platform that transforms millions of unstructured media data points into actionable insights for institutional investors, Kinlaw described the predictive benefit of media-derived narratives for currency forecasting. Three observations derived from the research include:

Quantifying narratives
Narratives play a crucial role in influencing currency markets and have the power to impact the financial markets. Media narratives can be understood and quantified based on the amount and tone of coverage a particular narrative receives. These factors help to gauge market sentiment, which in turn significantly impacts currency values, per Kinlaw. 

“Using the reservoirs of articles, we identified relevant narratives using keywords and then scored them based on the tone of the article — whether it is positive or negative,” he explained. Typically, when the tone was negative, the currency was negatively impacted. In short, narratives can provide valuable insights into currency market dynamics.

Exposure to currencies
Currencies exhibit meaningful, time-varying exposures to different narratives. Exposure refers to the amount of attention or coverage a given narrative gets from media, either directly or indirectly. This exposure is not static, but changes over time and across different currencies, and measuring the level of exposure can be useful for gauging currency trends. 

“We can determine whether narrative exposures to a currency is significant by assigning some thresholds,” Kinlaw explained. "It also lets us take an existing portfolio and ask the questions, ‘What narratives is this portfolio exposed to? If we see a shock in these narratives, what do we think is going to happen to this portfolio?’”

Forecasting returns
According to the researchers, understanding narrative exposures can improve the forecasting power of investors. “Positive moves or negative moves in the narratives that are associated with a currency statistically gives us some momentum that can be helpful in forecasting what's going on with the currency going forward,” said Kinlaw. Identifying which narratives a currency is exposed to can help in portfolio construction and risk management. Traders can build currency baskets or adjust existing portfolios based on narrative exposure. 

“The point is to really focus on the narrative exposure and just make sure that it's giving us some incremental information that we're not getting from the flow,” he added. 

Why should investors consider narratives as a significant factor for making better informed decisions? According to Kinlaw’s research, both their prevalence and tone significantly influence currency markets and decision-making, and ultimately shed light on the power of storytelling in financial markets.

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