Fiscal Cyclicality and Currency Risk Premia

Government surpluses load on a common factor, but to different degrees. In the cross-section, countries whose government surpluses are more cyclical with respect to the common factor tend to have higher nominal interest rates and higher currency returns. Their currency returns are also more exposed to a common risk factor, leading to a correspondence between the factor structure in government surpluses and the factor structure in currency returns. In a frictionless model, I show these results are consistent with the idea that currencies are priced as the claims to government surpluses.