Department of Economics

Lund University School of Economics and Management

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Central bank communication and asset correlations

The utilization of communication as a monetary policy instrument has increased since the global financial crisis in 2008. It is an efficient method to convey information to a large number of people and can influence the expectations of financial markets. Consequently, it is projected to impact various asset prices. The findings in a new PhD thesis from Lund University suggest that central banks' communications with a negative tone leads to a more negative correlation between stocks and bonds, supporting the "flight-to-quality" phenomenon in both the U.S. and Euro areas. However, the tone has mixed impacts on the correlation between stock prices and foreign exchange rates (FX). In the case of the Fed's negative sentiment, U.S. stock prices and the U.S. dollar move in opposite directions, while the ECB's negative sentiment causes Euro-area stock prices and the euro to move in the same direction.

By Duc Hong Hoang

Central banks implement monetary policy with the goal of addressing challenges to future economic growth and price stability. This is achieved by focusing on key macroeconomic variables such as inflation, output, interest rates, and exchange rates. Consequently, the decisions made with regards to monetary policy have an impact on the expectations of investors regarding future investment opportunities and returns. Central banks use a range of tools to execute monetary policy, including policy rates, market interventions, and asset purchase programs, but these may not always be effective when interest rates are near or below zero. In these cases, central banks may use policy statements and speeches by board members to communicate their views on economic conditions and policy decisions. These statements not only reflect economic and financial market conditions, but also the central bank's tone, which can be either positive or negative and impact the market. Studies have shown that central bank communication affects asset prices, (see e.g., Bernanke and Kuttner, 2005; Mueller et al., 2017; Lucca and Moench, 2015; Schmeling and Wagner, 2019) but less attention has been paid to its impact on the co-movement of asset prices. A new study included in the dissertation provides evidence of the effects of central bank communication on the co-movement of stock-bond and stock-FX returns.

Two channels may explain why the returns on stock-bond and stock-FX move together. Firstly, the expected returns of these assets are all affected by the same factors, where the interest rate, real growth, and inflation expectation are important drivers. Secondly, bond and FX returns are associated with stock returns as they are alternative investment options. Therefore, their correlation can be explained by slow-moving capital and international portfolio rebalancing, which suggests that investors allocate their portfolios by balancing the risk and return of assets across different markets. During times of high uncertainty or poor economic performance, investors tend to prefer safety assets like government bonds or safe haven currencies over risky assets.

The study

I measure the monthly sentiment of speeches from the Fed and the ECB, obtained from the Bank for International Settlement (BIS), by computing the difference between the number of positive and negative words and normalizing it by the total words of all speeches in a month. I then use a set of macroeconomic variables and policy interest rates to demonstrate that central banks' communications provide information on both the underlying state of the economy and future monetary policy guidance. This implies that central bank communication conveys additional information to outsiders who have limited access to information. To address the main questions, I use an established model to investigate if central bank sentiment influences the long-run (persistent) component of stock-bond and stock-FX correlation.

My empirical results show that central bank communication does matter for different markets’ volatility and correlations. When central banks express positive sentiments in their speeches, it has a calming effect on all three markets: stocks, bonds, and foreign exchange (FX). On the other hand, a negative tone in central bank speeches leads to an increase in volatility in these markets. Regarding the long-run correlation, I find that the correlation between stocks and bonds becomes more negative when central banks communicate negative sentiments. This finding supports for flight-to-quality phenomenon, where investors shift their investments from riskier assets, such as stocks, to safer ones, such as government bonds during the times of uncertainty or market volatility.

Additionally, central bank sentiment also affects the long-run correlation between stocks and FX. When the economy slows down, investors tend to demand safe haven currencies and safe haven currency-dominated assets. However, I found that the effects of central bank sentiment on stock-FX correlation are opposite in the US and Euro areas. In the US, negative central bank sentiment leads to more negative stock-FX correlation, implying that stock prices and the US dollar move in opposite directions, reflecting the US dollar's safe haven properties. However, this is not the case in the Euro areas where negative ECB sentiment causes stock prices and the euro to move in the same direction. I also find that the effects of central banks' sentiment on long-run stock-bond and stock-FX correlation differ between pre-global financial crisis and post-global financial crisis. One potential explanation could be that investors started paying more attention to central bank communication following the global financial crisis. In addition, after the crisis, government bonds emerged as a safe asset to investors, resulting in greater allocation of funds toward bonds and reduce preference for stocks in response to negative signals from central banks.

More from the author

This research was undertaken as part of the author’s PhD studies at the Department of Economics at Lund University. The thesis includes two additional papers examining different aspects of the currency markets. One paper investigates the risk premium of long-run and short-run volatility innovation in the currency market. The paper presents evidence that the two volatility innovations are priced differently in the currency market for different investment strategies. The other paper investigates the predictability of pre- Federal Open Market Committee (FOMC) news on the euro-dollar exchange rate, showing that a hawkish-dovish score of pre-FOMC news can predict exchange rate movement. Specifically, if pre-FOMC media signals a tightening policy, the dollar appreciates over two hours after the FOMC announcement, while a loosening monetary policy sentiment leads to the dollar depreciating against the Euro.


Bernanke, B.S. and Kuttner, K.N., 2005. What explains the stock market's reaction to Federal Reserve policy?. The Journal of Finance, 60(3), pp.1221-1257.

Lucca, D.O. and Moench, E., 2015. The pre‐FOMC announcement drift. The Journal of Finance, 70(1), pp.329-371.

Mueller, P., Tahbaz‐Salehi, A. and Vedolin, A., 2017. Exchange rates and monetary policy uncertainty. The Journal of Finance, 72(3), pp.1213-1252

Schmeling, M. and Wagner, C., 2019. Does central bank tone move asset prices?. Available at SSRN 2629978.




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about the author

This research was undertaken as part of the author’s PhD studies at the Department of Economics at Lund University. Read more about the dissertation: 

Essays on currency markets


Duc-Hoang Hoang
Doctoral student