FTSE 100 around FOMC announcements

The Federal Open Market Committee (FOMC) is the monetary policy-making body of the U.S. Federal Reserve System. Since 1981 the FOMC has had eight scheduled meetings per year, the timing of which is quite irregular, The schedule of meetings for a particular year is announced ahead of time [calendar here].

Starting in 1994, the FOMC began to issue a policy statement (“FOMC statement”) after the meetings that summarised the Committee’s economic outlook and the policy decision at that meeting. The FOMC statements are released around 14h15 Eastern Time.

Before 1994 monetary policy decisions were not announced; investors therefore had to guess policy actions from the size and type of open market operations in the days following each meeting. But since 1994 there has been far greater transparency over both the timing and the motivation for monetary policy actions.

This has led to a number of academic papers investigating the influence of these FOMC statements on financial markets. One such paper[1] found large average excess returns on U.S. equities in the 24-hour period immediately before the announcements (an effect the paper called the “Pre-FOMC Announcement Drift”). In other words, equities tended to be strong just before the FOMC statement. Further, these excess returns have increased over time and they account for sizable fractions of total annual realized stock returns. Quantifying this the paper says,

[since 1994] the S&P500 index has on average increased 49 basis points in the 24 hours before scheduled FOMC announcements. These returns do not revert in subsequent trading days and are orders of magnitude larger than those outside the 24-hour pre-FOMC window. As a result, about 80% of annual realized excess stock returns since 1994 are accounted for by the pre-FOMC announcement drift

A quite extraordinary finding!

And the relevance to UK equities is…?

The above quoted paper also found that such pre-FOMC excess returns occurred also in major international equity indices.

Let’s see if that is the case.

The following chart shows the average daily returns for the FTSE 100 Index for the seven days around the FOMC statements for the period 1994-2014. The seven days cover the three days leading up to the statement, the day of the statement itself A(0), and the then the three days after the statement. Given that the FOMC statement is usually released around 18h15 GMT (i.e. after the UK market has closed), A(0) can be taken as occurring in the 24 hours before the statement.

FTSE 100 around FOMC announcements

The result is quite clear, the average daily return for A(0) is 0.33%, over ten times greater than the average daily return on all other days. This does support the claim in the above referenced paper. It might also be interesting to note the weakness in equities on the day prior to the FOMC statement.


[1] David O. Lucca, Emanuel Moench, “The Pre-FOMC Announcement Drift” (2013)

Further articles on the Fed Rate and FOMC announcements.

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FOMC Cycle

According to a 2014 paper a strategy that bought the S&P 500 in the even weeks after FOMC announcements and sold in the odd weeks, would have seen a 650% return since 1994, against a market return of 505% for the period. The opposite strategy (i.e. buying in odd weeks) would have had negative returns.

The following chart comes from the WSJ reporting on the findings in the paper.

Even vs Odd Weeks [WSJ]

And this effect does not seem limited to the US market. The following chart, taken from the original paper, shows the international returns over the FOMC cycle. Where, WI is the world index, DMxUS is the developed market index excluding US, EM is the emerging market index. All indices are in USD.

International stock returns over the FOMC cycle [Vissing-Jorgensen]

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FOMC announcements and financial markets

The Federal Open Market Committee (FOMC) is the monetary policy-making body of the U.S. Federal Reserve System.

Since 1981, the FOMC has had eight scheduled meetings per year, the timing of which is quite irregular, The schedule of meetings for a particular year is announced ahead of time.

Starting in 1994, the FOMC began to issue a policy statement (“FOMC statement”) after the meetings that summarised the Committee’s economic outlook and the policy decision at that meeting. The FOMC statements are released around 2:15 pm Eastern Time. Before 1994 monetary policy decisions were not announced; investors therefore had to guess policy actions from the size and type of open market operations in the days following each meeting.

There has been academic interest in the influence of these announcements on the relationship between monetary policy actions and financial markets.

This article presents a brief review and listing of academic papers on FOMC announcements and financial markets.


Bomfim and Reinhart (2000) analysed the reaction of financial markets in the period after 1994 when the Federal Reserve started explicitly announcing its monetary policy decisions. They commented that the changes in disclosure practices potentially reduced the uncertainty about both the timing and the motivation for monetary policy actions. In their research they found little relation between the financial markets and the announcement of surprise decisions by the Fed. They concluded that Federal Reserve actions were more important for financial markets than their announcements.

The following year Kuttner (2001) analysed the impact of monetary policy actions on bill, note, and bond yields. Kuttner found that the response of interest rates to anticipated target rate changes was small, while their response to unanticipated changes was large and highly significant.

Regarding foreign exchange, Kalyvitis and Michaelides (2001) found evidence for an immediate overshooting effect for the US dollar in response to monetary policy shocks (unanticipated policy decisions). Andersen et al (2002), found that announcement surprises produced US dollar rate jumps, and concluded that high-frequency exchange rate dynamics are linked to fundamentals. They also observed that the market’s reaction was asymmetric: bad news having a greater impact than good news.

Bomfim (2003) focused on the stock market which was found to experience abnormally low volatility on days preceding scheduled policy announcements. Although this effect had been only significant in the previous four to five years. The paper also found that the element of surprise in announcements tended to boost stock market volatility significantly in the short run, with positive surprises (higher-than-expected values of the target federal funds rate) having a greater effect than negative ones.

Gurkaynak et al (2005) proposed that when investigating the effects of U.S. monetary policy on asset prices it was important to consider two factors: the current federal funds rate target and the future path of policy. By analysing high-frequency data from 1990 they found that both factors had important but differing effects on asset prices, and that FOMC statements had a much greater impact on longer-term Treasury yields.

Fleming and Piazzesi (2005) observed that while Treasury note yields were highly volatile around FOMC announcements, the average effect of Fed funds target rate surprises on such yields was less marked. Their explanation was that yield changes were dependent not only on the announcement surprises themselves but also on the shape of the yield curve at the time.

The most cited paper on this topic is Bernanke and Kuttner (2005) which attempted to quantify the effect of Fed actions and found that on average a hypothetical unanticipated 25-basis-point cut in the Federal funds rate target is associated with about a 1% increase in broad stock indexes. They also found that the effects of unanticipated monetary policy actions on expected excess returns accounted for the largest part of the response of stock prices.

Lucca and Trebbi (2009) presented a technique to automatically score the content of central bank communication about future interest rate decisions from various news sources. Applying this technique to FOMC statements they found that short-term nominal Treasury yields responded to changes in policy rates around policy announcements, whereas longer-dated Treasuries mainly reacted to changes in forward policy communication.

On the possible international effect, Hayo et al (2010) found that FOMC communication had a significant impact on European and, to a slightly lesser extent, Pacific equity markets. The following year Hausman and Wongswan (2011) broadened the scope to look at global asset prices and found that global equity indexes responded mainly to target surprises (changes to the current target federal funds rate); exchange rates and long-term interest rates responded mainly to the path surprises (revisions to the expected path of future monetary policy); and short-term interest rates respond to both surprises. They also found that the effect of FOMC announcements varied across countries, dependent on a country’s exchange rate regime (for equity and interest rates) and the scale of U.S. investment in the market (for equities).

Hanson and Stein (2012) challenged the standard model that macro policy can not move longer-term real rates, by finding that a 100 basis-point increase in the 2-year nominal yield on an FOMC announcement day is associated with a 42 basis-point increase in the 10-year forward real rate.

Previously most papers had looked at the effect of FOMC announcements on financial markets on the day of the announcement or subsequent to it, but Lucca and Moench (2013) found large average excess returns on U.S. equities in the 24-hour period immediately before the announcements. Further, these excess returns have increased over time and they account for sizable fractions of total annual realized stock returns (an extraordinary result). They found that such pre-FOMC excess returns occurred also in major international equity indices, although they found no such effect in U.S. Treasury securities and money market futures. On a similar topic Bernile et al (2014), found evidence of informed trading during lockup periods ahead of FOMC announcements. Putting a monetary figure on this action they estimated that informed traders’ aggregate dollar profits ranged between $14 and $256 million.

Madeira and Madeira (2014) looked at the votes of the FOMC members (made public since 2002) and found that equities increased when votes were unanimous but fell when there was dissent.

Cieslak et al (2014) documents an astonishing finding, that the US equity premium follows an alternating weekly pattern measured in FOMC cycle time. In other words, the equity premium is earned entirely in weeks 0, 2, 4 and 6 in FOMC cycle time (with week 0 starting the day before a scheduled FOMC announcement day).


INDEX (of papers listed below)

[Papers listed in reverse date order; indicates major paper.]

  1. Intelligent Trading of Seasonal Effects: A Decision Support Algorithm based on Reinforcement Learning [2014]
  2. Stock Returns over the FOMC Cycle [2014]
  3. Asset pricing: A tale of two days [2014]
  4. Can Information Be Locked-Up? Informed Trading Ahead of Macro-News Announcements [2014]
  5. Comparing U.S. and European Market Volatility Responses to Interest Rate Policy Announcements [2014]
  6. Dissent in FOMC meetings and the announcement drift [2014]
  7. Effects of explicit FOMC policy rate guidance on interest rate expectations [2013]
  8. The Pre-FOMC Announcement Drift [2013]
  9. How Much Do Investors Care About Macroeconomic Risk? Evidence from Scheduled Economic Announcements [2013]
  10. Is macroeconomic announcement news priced? [2013]
  11. Monetary Policy and Long-Term Real Rates [2012]
  12. Jumps, Interest Rates, and Monetary Policy [2012]
  13. The Timing of FOMC Monetary Policy Announcements and Intraday Trading Volume Patterns [2012]
  14. Global asset prices and FOMC announcements [2011]
  15. Does FOMC news increase global FX trading? [2011]
  16. The impact of U.S. central bank communication on European and pacific equity markets [2010]
  17. Measuring Central Bank Communication: An Automated Approach with Application to FOMC Statements [2009]
  18. Exchange Rates and FOMC Days [2007]
  19. What Explains the Stock Market’s Reaction to Federal Reserve Policy? [2005]
  20. Monetary Policy Tick-by-Tick [2005]
  21. Do Actions Speak Louder Than Words? The Response of Asset Prices to Monetary Policy Actions and Statements [2005]
  22. Eyes on the Prize: How Did the Fed Respond to the Stock Market? [2004]
  23. The Greenspan Effect on Equity Markets: An Intraday Examination of US Monetary Policy Announcements [2004]
  24. What the FOMC Says and Does When the Stock Market Booms [2003]
  25. Pre-announcement effects, news effects, and volatility: Monetary policy and the stock market [2003]
  26. Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange [2002]
  27. New evidence on the effects of US monetary policy on exchange rates [2001]
  28. Monetary policy surprises and interest rates: Evidence from the Fed funds futures market [2001]
  29. Making News: Financial Market Effects of Federal Reserve Disclosure Practices [2000]

 


Intelligent Trading of Seasonal Effects: A Decision Support Algorithm based on Reinforcement Learning
Authors [Year]: Dennis Eilers, Christian L. Dunis, Hans-Jörg von Mettenheim, Michael H. Breitner [2014]
Journal [Citations]: Decision Support Systems,
Abstract: Seasonalities and empirical regularities on financial markets have been well documented in the literature for three decades. While one should suppose that documenting an arbitrage opportunity makes it vanish there are several regularities that have persisted over the years. These include, for example, upward biases at the turn-of-the-month, during exchange holidays and the pre-FOMC announcement drift. Trading regularities is already in and of itself an interesting strategy. However, unfiltered trading leads to potential large drawdowns. In the paper we present a decision support algorithm which uses the powerful ideas of reinforcement learning in order to improve the economic benefits of the basic seasonality strategy. We document the performance on two major stock indices.
Ref: AA929
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