US Monetary Policy, Exchange Rates, and Delayed Portfolio Adjustments

What accounts for cross-country heterogeneity in exchange-rate responses to U.S. monetary policy shocks? Using daily data around Federal Open Market Committee (FOMC) announcements for 34 countries from 2001 to 2019, we show that countries with deeper financial markets experience larger currency depreciations following contractionary U.S. monetary policy shocks. This amplification is concentrated in forward-guidance shocks rather than contemporaneous target-rate surprises. The result is robust to alternative measures of financial market depth and to controls for domestic monetary policy responses, broad dollar movements, and various country characteristics. The amplification fades within approximately one month, suggesting that financial market depth matters primarily for high-frequency exchange-rate adjustment. A parsimonious portfolio-adjustment model interprets these empirical patterns by linking market depth to lower rebalancing costs and by treating forward guidance as news about future interest-rate differentials.