Deglobalization and Foreign Exchange Volatility: The Role of Supply Chain Pressures

This paper investigates the relationship between supply chain pressures and foreign exchange (FX) volatility in fundamentals-based component frameworks. We utilize mixed data sampling (MIDAS) volatility models that formalize FX rate volatility as a product of short- and long-run components. We allow the long-run component to be driven by the monthly global supply chain pressure (GSCPI) and the global economic conditions (GECON) indicators along with monetary and economic control variables. The dynamics governing short-run component of FX volatility is modeled via GARCH, GJR, Markov switching multifractal (MSM) and factorial hidden Markov volatility (FHMV) processes. Our analysis yields a statistically significant and positive relationship between supply chain pressures and foreign exchange volatility in both the developed and developing economies and across the different model specifications. The positive impact of global supply chain pressures is particularly prevalent during the post-2017 period which coincides with the beginning of Donald Trump's first term as president as the promised America first policy took effect. Out-ofsample tests further show that the information content in the global supply pressures index can help improve the accuracy of both the volatility and Value at Risk forecasts in the FX market. Our findings establish a clear link between proxies of deglobalization and foreign exchange volatility, while they also provide valuable insights that can be used in the management of currency exposures by firms.