Economic Countdown To The Olympics 3: A Winning FX Strategy
In part three of our five-part series tying the Olympics to economics (previously here and here), we note that in a rather surprising coincidence, the Olympics' host nation has been a rather simple tool to pick long-term 'winners' in the FX market. As Goldman points out, while we doubt that the Olympics directly affects the FX market, it has provided excellent long-term appreciation potential. We assume this means that the BoE will stop QE or we really don't see cable extending this performance record, though the findings suggest that systematically picking the 'next' host tends to pick winners more than losers.
Goldman Sachs: The Olympics As A Winning FX Strategy
Is it possible that the Olympics affect foreign exchange markets? At first glance, this may seem unlikely as the Olympics are a relatively small event when compared to the size of the Global FX market, which turns over several trillion Dollars every single day. However, from an economic point of view, the question does make some sense. In a standard open economy model, government spending such as constructing the Olympic sites and improving the infrastructure typically leads to real appreciation. Also, a country hosting the Olympics is likely to see an influx of visitors during the actual Games. This would be recorded as a services export in the balance of payments and, all else equal, it would increase the demand for local currency.
To investigate whether the Games do affect FX markets, we constructed a real effective exchange rate for the Olympics, by combining the Goldman Sachs Real Trade Weighted FX Indices (GS RTWI) of the host countries starting after the Moscow Olympics in 1980. For example, the GS RTWI for the Chinese Yuan is used between August 29, 2004 (the closing date of the Athens Olympics) and August 24, 2008 (the closing ceremony of the Beijing Olympics). For host cities in the Euro area, we use the Euro RTWI.
The Olympic RTWI has appreciated by around 90% since the end of the Moscow Olympics in 1980, which is vastly more than any other individual currency (apart from a few hyperinflation cases with highly unstable exchange rates).
The table shows that the currency with the second strongest real appreciation was the Japanese Yen: it has appreciated by around 54% since 1980, and remains substantially below the appreciation of our synthetic Olympic index. This suggests that individual currencies do tend to appreciate more than usual in the run-up to hosting the Olympics. By systematically picking the next hosting currency, the Olympic FX Index tends to pick ‘winning’ currencies more often than ‘losers’.
However, there are a few important caveats. First, the four-year periods preceding the Seoul 1988, Sydney 2000 and London 2012 Olympics saw the host currency depreciate. In other words, the Olympic FX Index is not guaranteed an FX Gold Medal. Second, real effective exchange rates can appreciate because of high inflation rather than nominal appreciation. Carry may be higher as well, meaning that investors may still be able to benefit, but Olympic currencies are not guaranteed to appreciate in nominal terms.
To check the performance of the Olympic currency, we calculated the return to date on an initial investment of $100 in the Olympic currency at the end of the Moscow Games, including carry. Following the host country rules laid out above, this would mean that at the end of the Beijing Olympics the investment would have been shifted out of Renminbi and into Sterling. Starting with $100 in 1980, this Olympic investment would currently be held in Sterling and worth about $1,020. In comparison, investing $100 in rolling 1-year USD investments would have returned only about $700.
In summary, the empirical results suggest that a synthetic Olympic currency would outperform over time. Even though Olympic investment spending is a relatively small share of GDP (for example, around 0.8% for the UK 2012 Games), one potential explanation is that there is a positive selection bias in picking the host city. For example, countries with strong growth in the years before a decision would be able to invest more in their Olympics bid, increasing the chances of winning the Games. This is even more so if growth is supported by a structural story that lasts longer than just one business cycle. The Beijing Olympics are an obvious recent example.
Overall, we continue to doubt that the Olympics directly affect the foreign exchange market. However, the Olympics may be a rather simple tool to pick long-term ‘winners’ in the FX market with good long-term appreciation potential.
Thomas Stolper and Constantin Burgi