Drivers of Post-pandemic Currency Movement: Recurring impacts of sovereign risks and oil prices

This paper tries to investigate the driving factors of FX rates, focusing on the roles of sovereign credit risks and energy prices in the post-pandemic period. We find that the yen’s safe-haven status has weakened, and the European currencies became more sensitive to debt risks and fragile to uncertainty. The yen’s sensitivity to higher sovereign risks increased after the introduction of the yield curve control (YCC) policy implemented by the Bank of Japan (BOJ), even if its policy could have reduced the volatility of Japan’s credit default swap (CDS) rates. Moreover, the type of shock (supply or demand) may change the impacts of oil prices on FX moves. Our results hint at the policy implication that the government’s fiscal policy stance is important not only for sovereign risk premiums but for exchange rate movement. The BOJ’s YCC could unintentionally limit some sovereign risks, but it may cause a rapid depreciation of the home currency when debt sustainability becomes more doubtful.