Fed Fighters Take NoteMay 25, 2016
Among the many catalysts behind the relentless increase in equity valuations in recent years must certainly be the easy monetary policy set by the Fed, which we have all become accustomed to and for which we will one day pay the piper. Beyond its rate stance, however, is the more interesting effect that the mere meeting of the FOMC has come to have on markets in general. It is not just Fed policy contributing to the state of affairs.
FOMC meeting dates are no secret, and thanks to the evolution of the group’s disclosures over the past three decades, neither are their discussions. Since 2004, the Fed has been publishing minutes 21 days after their meetings, with a separate statement issued at the time of the actual meeting. We all know these meetings are the subject of intense scrutiny by the investing public, and pundits’ forecasts of Fed actions are taken seriously. Whether you wish to know of these meetings or not, you cannot avoid the knowledge, as it unfailingly becomes the hot topic of financial newswires for days and weeks prior.
The chart below shows daily trading volume of the S&P 500 at the time of the last 10 meetings of the FOMC. Circled areas indicate the days surrounding FOMC meetings and attendant statements, with the nearby dates indicating the actual date of the meeting. Certainly other factors affect trading volume, but the fact that most of the volume spikes over this period coincided with weeks in which the FOMC met is not likely to be a simple coincidence.
Source: Bloomberg, FDx Advisors
This focus on the FOMC has in turn affected market participants’ behavior. Many studies have shown that over time, and to an increasing degree, large average excess returns to U.S. equities have occurred immediately in advance of monetary policy decisions. For example, a 2013 Staff Report written by David Lucca and Emanuel Moench of the Federal Reserve Bank of New York discusses the “Pre-FOMC Announcement Drift” phenomenon in detail. Since 1994, when monetary policy decisions were disclosed to the public by the FOMC immediately following their meetings, the authors document an average increase in the S&P 500 of 49 basis points in the 24 hours before a scheduled FOMC announcement. This increase does not revert in subsequent trading days, and is shown to be statistically significant. The effect is seen across industry and size factors. The study also examined other major U.S. macroeconomic news announcements, and determined they were not associated with a pre-announcement increase in equity prices. Most interestingly, the authors found the drift is not significantly different in monetary policy easing versus tightening cycles – it seems not to matter what the Fed’s stance is. No evidence of this drift was found prior to 1980, when the FOMC began announcing its policy decisions, using proxies for the market’s reaction to FOMC actions.
This phenomenon shows no sign of diminishing, and has in fact been seen to strengthen as time goes on. Broadly speaking, the period over which the authors found the phenomenon to occur has been one of generally falling rates from a peak in the early 80s, as seen in the chart below. Since meeting minutes were not released prior to this time, it is difficult to extrapolate these findings categorically to a period of generally increasing rates, despite the authors finding no difference in easing versus tightening cycles within the broader period of falling rates.
Perhaps this phenomenon is related to behavioral exuberance by investors expecting, and getting, continued easing from the Fed. But, whether this is an anomaly that will persist in a different interest rate regime or not, its prevalence in the current low rate environment should not be ignored by anyone looking to fight the Fed.
 Lucca, David, Emanuel Moench. The Pre-FOMC Announcement Drift. September 2011. Revised August 2013. FRBNY Staff Reports.