What Explains the Stock Market's Reaction to Federal Reserve Policy?

This paper analyzes the impact of changes in monetary policy on equity prices, with the objectives of both measuring the average reaction of the stock market and understanding the economic sources of that reaction. We find 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. Adapting a methodology due to Campbell and Ammer, we find that the effects of unanticipated monetary policy actions on expected excess returns account for the largest part of the response of stock prices.     

U.S. monetary policy indicators and international stock returns: 1970-2001

It is documented in the literature that U.S. and many international stock returns series are sensitive to U.S. monetary policy. Using monthly data, this empirical study examines the short-term sensitivity of six international stock indices (the Standard & Poor 500 [S&P] Stock Index, the Morgan Stanley Capital International [MSCI] European Stock Index, the MSCI Pacific Stock Index, and three MSCI country stock indices: Germany, Japan, and the United Kingdom) to two major groups of U.S. monetary policy indicators. These two groups, which have been suggested by recent research to influence stock returns, are based on the U.S. discount rate and the federal funds rate. The first group focuses on two binary variables designed to indicate the stance in monetary policy. The second group of monetary indicators involves the federal funds rate and includes the average federal funds rate, the change in the federal funds rate, and the spread of the federal funds rate to 10-year Treasury note yield. Dividing the sample period (1970-2001) into three monetary operating regimes, we find that not all policy indicators influence international stock returns during all U.S. monetary operating periods or regimes. Our results imply that the operating procedure and/or target vehicle used by the Federal Reserve Board (Fed) influences the efficacy of the policy indicator. We suggest caution in using any monetary policy variable to explain and possibly forecast U.S. and international stock returns in all monetary conditions.     

The Pre‐FOMC Announcement Drift

We document large average excess returns on U.S. equities in anticipation of monetary policy decisions made at scheduled meetings of the Federal Open Market Committee (FOMC) in the past few decades. These pre‐FOMC returns have increased over time and account for sizable fractions of total annual realized stock returns. While other major international equity indices experienced similar pre‐FOMC returns, we find no such effect in U.S. Treasury securities and money market futures. Other major U.S. macroeconomic news announcements also do not give rise to preannouncement excess equity returns. We discuss challenges in explaining these returns with standard asset pricing theory.     

The effects of U.S. quantitative easing on South Africa

This paper investigates the impact of the Federal Reserve’s monetary policy on the economy of South Africa, particularly during the period of quantitative easing and thereafter from 2009 to 2018. A VAR model, including South Africa’s inflation, output, a stock market index, exchange rate, and South Africa’s policy rate is examined to determine the impact of the Federal Reserve’s actions. Our results show that the Federal Reserve’s quantitative easing programs had only slight overall effects on South Africa’s economy. However, the way monetary policy is measured appears to have important effects for studies of international monetary spillovers as the results differ depending on the type of monetary policy measure used.     

Federal Reserve Monetary Policy and Industry Stock Returns

Recent studies identify stock return patterns associated with changes in Federal Reserve monetary policy. We find that these return patterns prevail across sixteen industry stock indices. However, significant cross-industry variation exists as the apparel industry exhibits mean annual returns that are 50% higher under an expansive Fed policy than under a restrictive policy, while the same return difference for the oil industry is only 20%. This cross-industry variation suggests that monetary conditions may be used by investors to estimate different expected returns across industries. Furthermore, the findings support the view that monetary considerations should be considered in ex ante asset pricing models such as the CAPM.     

Words that shake traders : The stock market's reaction to central bank communication in real time

This paper investigates the effects of Federal Reserve's decisions and statements on U.S. stock and volatility indices (Dow Jones Industrial Average, NASDAQ 100, S&P 500, and VIX) using a high-frequency event-study analysis. I find that both the surprise component of policy actions and official communication have statistically significant and economically relevant effects on equity indices, with statements having a much greater explanatory power of the reaction of stock prices to monetary policy. For instance, around 90% of the explainable variation in S&P 500 is due to the surprise component of Fed's statements. This paper also shows that equity indices tend to incorporate FOMC monetary surprises within 40 min from the announcement release. Finally, I find that these results are robust along several dimensions. In particular, I consider different estimators, such as the Generalized Empirical Likelihood, and I extend the sample to include the recent period of heightened financial stress. This sensitivity analysis corroborates that central bank communication about its future policy intentions is a key driver of stock returns.     

美联储货币政策对我国资产价格的影响

本文利用事件研究法考察了美联储货币政策对我国资产价格的影响。研究发现美联储货币政策会显著影响我国资产价格,美联储加息会降低我国债券和股票回报,降息则会提高债券和股票回报。将美联储货币政策进行细分后发现,预期到的货币政策调整对债券市场和股票市场的回报都有显著影响,而未预期到的货币政策调整和前瞻性指引只影响债券市场。进一步的研究表明,未预期到的美联储货币政策调整和前瞻性指引还会加剧我国金融市场的波动率。本文的研究结论为美联储货币政策对我国经济金融的影响提供了新的证据,对于投资者提高投资收益、降低投资风险以及货币当局完善我国货币政策调控和维护我国金融市场稳定具有重要意义。     

Equity prices and financial globalization

This paper examines the association between equity returns, economic shocks, and economic integration. The empirical findings show that oil prices and U.S. Federal Reserve funds rates are associated with negative responses of international equity returns, of which a simple asset-pricing model is capable of explaining the international differences. Using vector autoregressions, we find that the effects of global economic shocks operate through the current excess returns of equity prices. Empirically, trade integration increases the responses of international equity returns to oil prices, while finance integration increases the responses of equity returns to Federal Reserve funds rates across countries.     

What determines the stock market's reaction to monetary policy statements?

We find that information communicated through monetary policy statements has important business cycle dependent implications for stock prices. For example, during periods of economic expansion, stocks tend to respond negatively to announcements of higher rates ahead. In recessions, however, we find a strong positive reaction of stocks to seemingly similar signals of future monetary tightening. We provide evidence that the state dependence in the stock market's response is explained by information about the expected equity premium and future corporate cash flows contained in monetary policy statements. We also show state dependence in the average stock returns on days of scheduled FOMC meetings and in the impact of monetary policy statements on stock and bond return volatility.     

What explains the lack of monetary policy influence on bank holding companies?

In this paper, we investigate how monetary policy innovations affect the equity returns of bank holding companies (BHCs). We also examine bank characteristics to determine what explains the cross-sectional and time-series variation in the returns' sensitivity. Similar to non-financial firms, we find that only unanticipated components affect bank equity returns; however, this effect is absent in the second half of our sample period. Smaller, less liquid banks have higher sensitivity; a higher ratio of time deposits to total deposits reduces this sensitivity. A higher ratio of non-interest income to total income also reduces this sensitivity, while capital-constrained banks have a higher sensitivity to monetary policy innovations. We argue that a higher dependence on non-interest income and the use of interest rate derivatives together may explain the disappearing influence of monetary policy on these BHCs.     

EFFECT OF FEDERAL RESERVE POLICIES ON BANK EQUITY RETURNS

We investigate the reaction of bank equity returns to changes in the relevant Federal Reserve (Fed) policy tool, which is the federal funds rate during periods of interest rate targeting and the discount rate during periods of reserves targeting. Three policy periods from 1974 to 1996 are investigated. We find that bank equity returns are inversely related to changes in the relevant Fed policy tool and that the degree of sensitivity of bank equity returns is conditioned on the direction of the change in the Fed policy tool. Also, we find that values of larger commercial banks and low‐capital‐ratio commercial banks are more exposed to changes in the relevant Fed policy tool. JEL classification: G11, G12, G14.     

THE INTERACTION OF MONETARY POLICY AND STOCK RETURNS

The “irrational exuberance” of the stock market in the late 1990s led to a discussion of the appropriate policy response by monetary authorities. Any response would be contingent on the stock market reaction to policy shocks. In this study, I employ a structural vector autoregression to estimate the response of the stock market returns to innovations in the federal funds rate. The role of the stock market in the Federal Reserve policy rule can also be examined empirically.     

Stock Market Reaction to Monetary Policy: An Event Study Analysis of the Brazilian Case

This article examines the relationship between the monetary policy implemented by the Central Bank of Brazil and the stock market. We implement event study analysis and analyze the effect of the anticipated and unanticipated components of monetary policy decisions on the returns of the IBOVESPA index and 53 stocks. We find that monetary policy has a significant effect on the stock market, but is only responsible for a small proportion of market variation. The analysis at the sector level with expected returns identifies that the financial sector is the most affected by this policy, whereas with excess returns only industrial goods are significantly affected. Moreover, individual assets respond in a rather heterogeneous fashion to monetary policy; however, when we look at excess returns, we identify a reduction in the intensity and in the number of companies impacted by monetary policy. Finally, the monetary shock is explained by unanticipated variations in the unemployment rate, in the Industrial Production Index, in the General Market Price Index, and in the Broad Consumer Price Index.     

REGIME CHANGES IN STOCK RETURNS

This paper studies three sources of instability in parameter estimates of stock return models (1) time-varying expected mean returns, (2) time-varying return volatility and (3) changing institutional factors. We model United States stock returns as a function of a constant expected return and financing costs resulting from an institutional feature, delayed delivery. We examine two eight-year periods and find that both contain a regime shift driven by an abrupt change in volatility. The first occurs during an international monetary crisis amid important Watergate developments. The second is on the first trading day after the reappointment of Paul Volcker as the chairman of the United States Federal Reserve Board.     

Monetary Policy and the Cross-Section of Expected Stock Returns

Ample evidence shows that size and book-to-market equity explain significant cross-sectional variation in stock returns, whereas beta explains little or none of the variation. Recent studies also demonstrate that proxies for monetary stringency increase the explained variation in stock returns. We reexamine a three-factor model that includes beta, size, and book-to-market equity, while allowing monetary conditions to influence the relations between these risk factors and average stock returns. We find that ex-ante proxies for monetary stringency significantly influence the relations between stock returns and all three risk factors. Additionally, all three variables are found to contribute significantly to explaining cross-sectional returns in a three-factor model that includes the monetary sector.     

Do FOMC minutes matter to markets? An intraday analysis of FOMC minutes releases on individual equity volatility and returns

This paper examines the 2006 to 2007 time period to determine the extent to which the release of the Federal Reserve minutes affects equity volatility and returns for 2832 individual firms. Using intraday data, we find that equity returns are essentially unaffected by FOMC minutes releases. We do find evidence of volatility effects, in that conditional volatility is lower prior to the minutes release and higher after the minutes release on release days, relative to a “control” day one week prior to the release date. These differences manifest at the 2:00–2:05 pm interval, and generally dissipate within 15 min. Consistent with previous literature, we also find evidence of both industry-specific and firm size effects in our data. Finally, we see that volatility is higher (lower) when the minutes are released after the Federal Reserve engages in restrictive (expansionary) monetary policy. Our results are robust to a variety of different definitions of the “control” dates, as well as differing industry definitions.     

On Stock Market Returns and Monetary Policy

Financial economists have long debated whether monetary policy is neutral. This article addresses this question by examining how stock return data respond to monetary policy shocks. Monetary policy is measured by innovations in the federal funds rate and nonborrowed reserves, by narrative indicators, and by an event study of Federal Reserve policy changes. In every case the evidence indicates that expansionary policy increases ex-post stock returns. Results from estimating a multi-factor model also indicate that exposure to monetary policy increases an asset's ex-ante return.     

The channels of monetary policy triggered by central bank actions and statements in the Australian equity market

Owing to the discrete disclosure practices of the Reserve Bank of Australia, this paper provides new evidence on the channels of monetary policy triggered by central bank actions (monetary policy announcements) and statements (explanatory minutes releases), in the Australian equity market. Both monetary policy announcements and explanatory minutes releases are shown to have a significant and comparable impact on the returns and volatility of the Australian equity market. Further, distinct from US and European studies that find strong evidence of the interest rate, bank loan and balance sheet channels and no evidence of the exchange rate channel following central bank actions, this paper finds that monetary policy impacts the Australian equity market via the exchange rate, interest rate and bank loan channels of monetary policy, with only weak evidence of the balance sheet channel of monetary policy. These channels are found to be operating irrespective of the trigger (monetary policy announcements or explanatory minutes releases), though results are somewhat weaker when examining the explanatory minutes releases. These results have important implications for central bank officials and financial market participants alike: by confirming a comparable avenue to affect monetary policy; and providing an explication of its impact on the Australian equity market.     

Eyes on the prize: How did the fed respond to the stock market?

Since the stock market boom of the 1990s, many have suggested the Federal Open Market Committee (FOMC) has adopted an unannounced policy goal of supporting equity values. This paper offers a new approach to disentangle the relationship between changes in equity values and monetary policy. Specifically, the paper distinguishes the FOMC's reaction to forecasts of traditional goal variables, which may depend on equity prices, from the FOMC's independent reaction to changes in equity prices. By using actual forward-looking variables examined by the FOMC before each action (the “Greenbook” forecasts), the authors find little evidence to support the proposition that the FOMC responds to stock values, except as filtered through a forecast of accepted monetary policy goal variables.     

Simultaneous monetary policy announcements and international stock markets response: An intraday analysis

This paper investigates the return and volatility response of major European and US equity indices to monetary policy surprises by utilizing extensive intraday data on 5-min price quotes along with a comprehensive dataset on monetary policy decisions and macroeconomic news announcements. The results indicate that the monetary policy decisions generally exert immediate and significant influence on stock index returns and volatilities in both European and the US markets. The findings also show that press conferences held by the European Central Bank (ECB) that follow monetary policy decisions on the same day have a clear impact on European index return volatilities. This implies that they convey additional important information to market participants. Overall, our analysis suggests that the use of high frequency data is critical to separate the effect of monetary policy actions from those of macroeconomic news announcements on stock index returns and volatilities.