US Fiscal Cycle and the Dollar

A stronger US fiscal condition predicts a higher excess return on the dollar against foreign currencies in the following year, and more so against foreign currencies with higher dollar betas. Through the lens of a no-arbitrage model, I use these findings to refine our understanding of the currency factor structure. I find the variation in the dollar's risk premium is driven predominantly by a global state variable that also affects foreign currencies' risk premia and interest rate differentials, whereas the previous literature attributes the variation in the dollar's risk premium entirely to US-specific business conditions.