The FOMC will make an announcement this Wednesday following their policy meeting. No substantial changes are anticipated, and rates should remain unchanged.
Let’s take a look at a few papers analyzing how the markets react to FOMC announcements, and what we may be in for in the week ahead.
Since the Federal Open Market Committee (FOMC) began announcing its monetary policy decisions in 1994, U.S. stocks have experienced large excess returns in the twenty-four hours preceding these announcements. These abnormal returns account for more than 80 percent of the U.S. equity premium over the past seventeen years. Other major international equity indexes have experienced similar abnormal returns before FOMC announcements. However, no such return pattern is detectable on U.S. fixed income assets or the exchange value of the dollar.
Stock market beta is strongly related to average returns on days when important macroeconomic news about inflation, unemployment, or interest rates is scheduled for announcement. This positive relationship holds for individual stocks, various test portfolios, and even bonds, suggesting that beta is after all an important measure of systematic risk. Growth stocks, small stocks, the market itself, and long-term bonds all significantly outperform on announcement days. Contrary to evidence of mean-reversion in non-announcement day returns at longer horizons, there is no mean reversion in announcement day returns at horizons of up to seven years, indicating that announcement day returns are primarily affected by news about the long-run.
Stock market average returns and Sharpe ratios are significantly higher on days when important macroeconomic news about inflation, unemployment, or interest rates is scheduled for announcement. The average announcement day excess return from 1958 to 2009 is 11.4 basis points versus 1.1 basis points for all the other days, suggesting that over 60% of the cumulative annual equity risk premium is earned on announcement days. The Sharpe ratio is ten times higher. In contrast, the risk-free rate is detectably lower on announcement days, consistent with a precautionary saving motive. Our results demonstrate a trade-off between macroeconomic risk and asset returns, and provide an estimate of the premium investors demand to bear this risk.