Stock returns over the FOMC cycle - Berkeley Haasfaculty.haas.berkeley.edu/vissing/cycle_slides.pdf2 OUR NEW FACT From 1994‐2015 the US equity premium Follows an alternating weekly

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Stock returns over the FOMC cycle

Anna Cieslak, Duke University Adair Morse, UC Berkeley and NBER

Annette Vissing‐Jorgensen, UC Berkeley, NBER and CEPR

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OUR NEW FACT

From 1994‐2015 the US equity premium

Follows an alternating weekly pattern measured in FOMC cycle time, i.e. in time since the last FOMC meeting.

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).

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Stock returns over the FOMC cycle, 1994‐2015 Average 5‐day stock return minus bill return over the FOMC cycle, percent

Based on 176 FOMC cycles (8 scheduled FOMC meetings per year). The numbers along the line indicate the value on the horizontal axis. Note: If a given day is day ‐6 or closer to the next meeting, the 5‐day (forward) return for this day is not used in the right part of the graph, so points to the right do not use any data for days ‐2 and later.

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We got interested in the FOMC cycle because of Lucca and Moench (2015)’s finding: The stock market on average does well (50bps) the 24 hours from 2pm‐2pm before the FOMC announcement

Savor and Wilson (2013): Has a related finding about high returns on macro announcement days. L&M shows that the FOMC returns are earned before the announcement which is likely informative about the mechanism (more later).

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Our argument: 1) The bi‐weekly FOMC cycle in excess stock returns is statistically robust

2) It’s driven by news from the Fed: A ``Fed put” plays a large role, but possibly also a risk premium component.

3) The news is generated around the time of board meetings of the Board of Governors and makes its way into markets mainly via informal communication (as opposed to Fed announcements) over the following days. A central component of this news is likely to be information about voting at the next FOMC meeting.

4) The Fed has several motives for using informal communication. Understanding the motives helps make it plausible that informal communication is systematic

Some of the motives are not socially optimal. Less informal communication would be preferable for society.

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Statistical robustness: Each of the peaks is statistically significant

Let day 0 in event time by the date of the FOMC announcement. Week ‐1: Days ‐6,…,‐2 Week 0: Days ‐1,…,3 Week 1: Days 4,…,8 Week 2: Days 9,…,13 Week 3: Days 14,…,18 Week 4: Days 19,…,23 Week 5: Days 24,…,28 Week 6: Days 29,…,33

Test whether average excess return in even weeks in FOMC cycle time is statistically different from that in odd weeks in FOMC cycle time.

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Regressions of daily excess stock returns on FOMC cycle dummies, 1994‐2015

Dependent variable: Excess return on stocks over T‐bills

(1) (2) Dummy=1 in Week 0 0.138*** 0.138***

(3.00) (3.00) Dummy=1 in Week 2, 4, 6 0.106***

(3.03) Dummy=1 in Week 2 0.083*

(1.88) Dummy=1 in Week 4 0.117**

(2.37) Dummy=1 in Week 6 0.201**

(2.21) Constant ‐0.024 ‐0.024

(‐1.17) (‐1.17) N (days) 5736 5736 Note: t‐statistics robust to heteroscedasticity in parenthesis. The left hand side variable is in percent, so (for example) 0.1 means 10 basis points per day. *** indicates significance at the 1 pct level, ** significance at the 5 pct level, and * significance at the 10 pct level.

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Robustness across sub‐samples: Three sub‐periods of 1994‐2015

Stock returns over the FOMC cycle, by time period. Average 5‐day excess return, t to t+4 (percent)

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252525252525252525252525252525252525252525252525252525252525252525252525252525252525252525252525252525252525

262626262626262626262626262626262626262626262626262626262626262626262626262626262626262626262626262626262727272727272727272727272727272727272727272727272727272727272727272727272727272727272727272727272727

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2929292929292929292929292929292929292929292929292929292929

30303030303030303030303030303030

3131313131313131313131313131313132323232323232323232323232323232

333333333333333333

-.5-.2

50

.25

.5.7

51


1994-2006

-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5

-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4

-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3

-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2

-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1000000000000000000000000000000000000000000000000000000000000000000000000

111111111111111111111111111111111111111111111111111111111111111111111111

222222222222222222222222222222222222222222222222222222222222222222222222333333333333333333333333333333333333333333333333333333333333333333333333

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888888888888888888888888888888888888888888888888888888888888888888888888

999999999999999999999999999999999999999999999999999999999999999999999999

101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010

111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111

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242424242424242424242424242424242424242424242424242424242424242424242424242424242424242424

252525252525252525252525252525252525252525252525252525252525252525

262626262626262626262626262626262626262626262626262626262626262626

272727272727272727272727272727272727272727272727272727272727272727

2828282828282828282828282828282828282828282828282828292929292929292929

3030303030

3131313131

3232323232

3333333333

-.5-.2

50

.25

.5.7

51


2007-2015

10

What about pre‐1994?

Note: Sample starts with 1982 Sept 27 (first date of Fed funds target). Black Monday Oct 19, 1987 omitted.

There are again four peaks, but the first “valley” is not as low and pattern is sensitive to starting date.

-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5

-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4

-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3

-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2

-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-10000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000

1111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111 22222222222222222222222222222222222222222222222222222222222222222222222222222222222222222223333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333

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5555555555555555555555555555555555555555555555555555555555555555555555555555555555555555555

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7777777777777777777777777777777777777777777777777777777777777777777777777777777777777777777 8888888888888888888888888888888888888888888888888888888888888888888888888888888888888888888

999999999999999999999999999999999999999999999999999999999999999999999999999999999999999999

101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010101010

111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111

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2020202020202020202020202020202020202020202020202020202020202020202020202020202020202020202020202020202020202020202020202020202020202020202020202020202021212121212121212121212121212121212121212121212121212121212121212121212121212121212121212121212121212121212121212121212121212121212121212121212121212121

22222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222

232323232323232323232323232323232323232323232323232323232323232323232323232323232323232323232323232323232323232323232323232323232323232323

24242424242424242424242424242424242424242424242424242424242424242424242424242424242424242424242424242424

2525252525252525252525252525252525252525252525252525252525252525252525252525252525252525252525

26262626262626262626262626262626262626262626262626262626262626262626262626262626262626262626

2727272727272727272727272727272727272727272727272727272727272727272727272727272727272727

28282828282828282828282828282828282828282828282828282828282828282828

2929292929292929292929292929292929292929292929

3030303030303030303030303030

31313131313131313131313131

32323232323232323232323232

333333333333333333333333

-.20

.2.4

.6


11

Regressions of daily excess stock returns on FOMC cycle dummies, various periods

Dependent variable: Excess return on stocks over T‐bills (1) (2) (3) (4) (5) (6)

1982M9‐1993

1994‐2006

2007‐2015

1982M9‐1993

1994‐2006

2007‐2015

Dummy=1 in Week 0 0.075* 0.104** 0.188** 0.075* 0.104** 0.188** (1.78) (2.13) (2.14) (1.78) (2.13) (2.14) Dummy=1 in Week 2, 4, 6 0.087** 0.093** 0.123**

(2.48) (2.28) (2.01) Dummy=1 in Week 2 0.072 0.059 0.118 (1.63) (1.11) (0.06) Dummy=1 in Week 4 0.087* 0.116** 0.120

(1.71) (2.02) (1.40) Dummy=1 in Week 6 0.171** 0.185* 0.233 (2.37) (1.92) (1.07) Constant 0.004 ‐0.015 ‐0.037 0.004 ‐0.015 ‐0.037

(0.19) (‐0.63) (‐1.02) (0.19) (‐0.63) (‐1.02) N (days) 2936 3387 2349 2936 3378 2349

12

Same bi‐weekly pattern in FOMC cycle time for non‐US stocks

International stock returns over the FOMC cycle, percent, 1994‐2015

Note: To account for time zone differences, we use returns realized on day t+1 relative to the US calendar. MSCI indices are obtained from Bloomberg. Returns are in USD but the pattern is not driven by the dollar.

13

International stock returns over the FOMC cycle, 1994‐2015 Dependent variable: One‐day return on an MSCI equity index on day t+1

DMxUS EM WI (1) (2) (3) (4) (5) (6)

Dummy=1 in week 0 0.140*** 0.140*** 0.184*** 0.184*** 0.124*** 0.124*** (3.29) (3.28) (3.95) (3.95) (3.33) (3.33)

Dummy=1 in week 2 4 6 0.089*** 0.172*** 0.092*** (2.91) (4.97) (3.34)

Dummy=1 in week 2 0.078** 0.190*** 0.082** (2.10) (4.39) (2.40)

Dummy=1 in week 4 0.0782* 0.136*** 0.091** (1.80) (2.80) (2.35)

Dummy=1 week 6 0.245*** 0.282*** 0.181** (2.92) (3.56) (2.58)

Constant ‐0.0333* ‐0.0333* ‐0.0681*** ‐0.0681*** ‐0.0263 ‐0.0263 (‐1.76) (‐1.76) (‐3.21) (‐3.21) (‐1.52) (‐1.52)

N (days) 5735 5735 5735 5735 5735 5735

14

Economic significance: Trading strategies based on the FOMC cycle, 1994‐2015

Trading strategy:

Average annual excess return

Standard deviation of annual excess

return

Sharpe ratio for annual returns

Standard buy and hold strategy

A. Hold stocks all the time 8.26 19.12 0.43

Alternating FOMC week strategies for the overall stock market

B. Hold stocks in weeks 0, 2, 4, 6 only 11.77 13.33 0.88

Hold stocks in week 0 only 4.73 8.63 0.55 Hold stocks in week 2 only 2.33 6.50 0.36 Hold stocks in week 4 only 3.31 6.43 0.52 Hold stocks in week 6 only 1.01 1.57 0.64

C. Hold stocks in weeks ‐1, 1, 3, 5 only ‐3.00 14.55 ‐0.21

D. Long stocks in weeks 0, 2, 4, 6 and 14.78 21.12 0.70 short stocks in weeks ‐1, 1, 3, 5 (strategy B minus strategy C)

15

What about the bond market? Excess returns on 10‐year/2‐year Treasury bonds over 30‐day T‐bills, 1994‐2014 Average 5‐day excess return, t to t+4 (percent)

For 10‐year Treasury excess return over bills, week 0, 2, and 4 peaks present, not week 6 peak, and nothing is significant

-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6

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-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4

-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3

-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1

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.1.2

.3


10-year bonds 2-year bonds

Avg

. bon

d m

inus

T-b

ill re

turn

, t to

t+4

(pct

)

16

Why your prior should be that results for bonds would be weak:

Day 0 evidence (plausibly driven by monetary policy news) suggests a much stronger and more significant effect of monetary policy on stocks than on bonds

Regressing day 0 excess returns over 30‐day T‐bills on dummy for day zero, 1994‐2015:07

FOMC day dummy (t‐stat) Constant (t‐stat) N (days)

Equity 0.305 (3.36) 0.022 (1.40) 5627 1Y bond 0.004 (1.03) 0.002 (3.09) 5627 2Y bond 0.006 (0.58) 0.004 (3.07) 5627 5Y bond 0.024 (0.88) 0.009 (2.55) 5627 7Y bond 0.020 (0.52) 0.012 (2.45) 5627 10Y bond 0.026 (0.58) 0.011 (1.87) 5627 20Y bond 0.013 (0.20) 0.020 (2.14) 5627 30Y bond 0.018 (0.23) 0.017 (1.52) 5627

Only stocks have (nominal) cash flow risk. And stock‐bond correlation is negative over most of the sample

17

EVIDENCE THAT THE NEW FACT IS DRIVEN BY FED NEWS

Background: Known that news about monetary policy mainly comes out in between meetings, not at the FOMC announcement When Fed changes FF target, this is to a large extent expected by the day before.

Expected and (Kuttner Fed funds futures based) surprise components of federal funds target changes in basis points, daily data, 1994‐2008:06

Actual change

Number of changes

Avg. expected change

Avg. surprise

Avg. absolute value of surprise

‐75 1 ‐92 17 17 ‐50 8 ‐42 ‐8 9 ‐25 12 ‐25 0 5 0 65 1 ‐1 2 25 25 25 0 2 50 4 41 9 9 75 1 61 14 14

18

1) The FOMC calendar is quite irregular and changes across sub‐periods over which our finding is robust

Since 1981, the FOMC meets at scheduled times 8 times per year. The schedule of meetings for a particular year is announced ahead of time.

But the time between meetings varies across meetings and years. Schedule does not line up with any kind of bi‐weekly timing in regular calendar time.

19

Timing of the eight FOMC meetings within the year

Histogram of the day of the year on which FOMC meetings took place, 1994‐2015

01

23

4Fr

eque

ncy

0 30 60 90 120 150 180 210 240 270 300 330 360Day of the year

20

Histogram of the day of the year on which FOMC meetings took place, by sub‐period

Note: Vertical lines are inserted every 60 days in order to facilitate comparisons across the three graphs.

01

23

01

23

0 60 120 180 240 300 360

1994-2006

2007-2015

Freq

uenc

y

Day of the yearGraphs by sub-period

21

2) Even weeks in FOMC cycle time do not line up with reserve maintenance periods, with other macro releases, or with corporate earnings announcements

Reserve maintenance periods: Controlling for day‐of‐the‐RMP dummies doesn’t affect our results

Macro releases: Controlling for the (importance‐weighted) number of announcements doesn’t change our results

Data for all non‐FOMC macro announcements in Bloomberg for Nov 1996‐Dec 2015. 19,167 non‐Fed macro releases. Number of releases per day ranges from 0 to 26 with an average of 3.3.

Over 164 different types of macro data releases, with 106 types having at least 50 releases over the sample period.

The data includes a “relevance” variable which is between 0 and 1 and measures how many Bloomberg users have set up ``alerts’’ for that macro variable.

22

Number of macro announcements per day in FOMC cycle time, Bloomberg data 1996:11‐2015:12.

23

Regressions of daily excess stock returns on FOMC cycle dummies with controls for non‐Fed news, 1994‐2015

Dependent variable: Excess return on stocks (1) (2) (3) (4) (5) (6)

Dummy=1 in Week 0 0.138*** 0.134*** 0.138*** 0.131*** 0.139*** 0.138*** (3.00) (2.90) (2.99) (2.80) (3.01) (3.00)

Dummy=1 in Week 2, 4, 6 0.106*** 0.105*** 0.106*** 0.0949*** 0.107*** 0.105*** (3.03) (3.00) (3.04) (2.72) (3.05) (3.02)

Number of macro releases, 0.013* relevance weighted (1.81) Number of corp. earning 0.603 Announcements (10‐4) (0.36) Fraction of positive earnings ‐0.007 surprises (‐0.08) Dummies for day of week/month, end of month/quarter/year

Yes

Dummies for day in the reserve Yes maintenance period Dummy for high payment flow days Yes Constant ‐0.0238 ‐0.049** ‐0.026 0.068 ‐0.222 ‐0.025

(‐1.17) (‐2.07) (‐0.55) (0.73) (‐0.85) (‐1.18) N (days) 5736 5736 5736 5736 5736 5736

24

3) Volatility in the federal funds market (but not to the same extent in other markets) peaks during even weeks in FOMC cycle time

Changes in expected monetary policy will be reflected in effective federal funds rate, if:

Financial institutions adjust their demand for federal funds in expectation of/in reaction to news about the future federal funds rate

The Fed’s open markets desk does not fully adjust its open markets operations to keep the effective funds rate equal to the current target rate.

25

Volatility in the effective federal funds rate over the FOMC cycle, 1994‐2015

This bi‐weekly pattern in effective federal funds rate volatility is not driven by known determinants of EFF rate volatility:

The reserve maintenance period. High payment flow days (when banks have higher demand for reserves).

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-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3

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0.1

.2.3

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Std. dev. of daily yield change, avg. across day t to t+4

26

4) The ``Fed put’’ in stock returns and Federal funds target changes

Following poor stock returns:

a) The stock market partly mean‐reverted, but only in even weeks! b) The Fed lowered the Federal funds target rate

Both effects look like “puts” because they only show up for the lowest quintile of past stock returns.

Suggests that the Fed reacted more accommodating to bad stock market news than the market expected, driving even‐week mean‐reversion.

In a second paper we are now investigating how the Fed’s views about employment and inflation depend on the stock market and whether there is an effect of the stock market on Fed policy even beyond that.

27

The Fed put in stock returns: Even‐week mean‐reversal

Avg. excess return on day t as a function of avg. 5‐day excess return over day t‐5 to t‐1, even versus odd weeks in FOMC cycle time

Daily data for all 5736 obs. are sorted into five buckets based on quintiles of 5‐day excess return over day t‐5 to t‐1

-.10

.1.2

.3

-.04 -.02 0 .02 .04Average 5-day excess returns, day t-5 to t-1

Even weeks Odd weeks

Ave

rage

1-d

ay e

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s re

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t

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Each of the even weeks

-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1

-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1 -1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1 -1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1

1111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111

111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111

1111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111

111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111

11111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111

33333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333

3333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333

333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333

3333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333

333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333333

55555555555555555555555555555555555555555555555555555555555555555555555555

5555555555555555555555555555555555555555555555555555555555555555555555555555555555555

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-.3-.2

-.10

.1.2

.3.4

.5.6


Each of the odd weeks

29

Main regression, by quintile of excess return over various look‐back periods

Regressions of excess stock returns on even week dummies for various categories of observations based on lagged excess stock returns

Quintile (last

week)=1 (low)

Quintile (last

week)=2

Quintile (last

week)=3

Quintile (last

week)=4

Quintile (last

week)=5 (high)

Quintile(last week)=1 and

Quintile(last month)=1

Quintile(last week)=1 and Quintile(last month)=1 and Quintile(last 3 months)=1

Dummy=1 in Week 0 0.354** 0.157* 0.0539 0.0732 0.0769 0.609** 1.049**

(2.305) (1.720) (0.635) (0.803) (0.878) (2.284) (2.141) Dummy=1 in Week 2 0.321** 0.112 ‐0.0671 ‐0.00765 0.0753 0.546** 0.667*

(2.057) (1.409) (‐0.877) (‐0.113) (0.806) (2.131) (1.711) Dummy=1 in Week 4 0.282* 0.101 0.0251 ‐0.0202 0.195* 0.533** 0.712*

(1.898) (0.988) (0.231) (‐0.285) (1.839) (2.117) (1.837) Dummy=1 in Week 6 0.608*** ‐0.222 0.196 0.191 ‐0.0633 0.893*** 1.404***

(3.159) (‐0.948) (1.181) (1.330) (‐0.299) (3.081) (3.728) Constant ‐0.0355 ‐0.0759* 0.0334 ‐0.0128 ‐0.0285 ‐0.0786 ‐0.104

(‐0.541) (‐1.842) (0.968) (‐0.373) (‐0.657) (‐0.735) (‐0.649) N (days) 1148 1147 1147 1147 1147 598 354

30

Decomposition of log stock returns

Sum of ln(1+rm) for various categories of observations based on lagged

excess stock returns

All days Even weeks Odd weeks

1.91 (n=5736) 2.54 (n=2669) ‐0.62

Quintile(last week)=1 (low) 1.32 (n=1148) 1.57 (n=531) ‐0.24 Quintile(last week)=2 ‐0.20 (n=1148) 0.22 (n=541) ‐0.43 Quintile(last week)=3 0.50 (n=1147) 0.26 (n=543) 0.24 Quintile(last week)=4 0.04 (n=1146) 0.08 (n=546) ‐0.03 Quintile(last week)=5 (high) 0.25 (n=1147) 0.41 (n=508) ‐0.16

1.91 (n=5736) 2.54 (n=2669) ‐0.62

Quintile(last week)=1 and Quintile(last month)=1 1.10 (n=598) 1.38 (n=280) ‐0.28 Quintile(last week)=1 and Quintile(last month)=1 and Quintile(last 3 months)=1 0.89 (n=354) 1.12 (n=161) ‐0.23

31

The Fed put in Federal funds target changes (1994‐2008 data):

Accommodation following low intermeeting excess returns Intermeeting excess return: Excess return from day 1 of cycle N‐1 to day ‐2 of cycle N. Define 5 quintiles based on this variable. Cumulative Federal funds target change from day 0 of cycle N‐1 to day 0 of cycle N+7 (approximately a one‐year period) as a function of the intermeeting excess return.

-1.5

-1-.5

0.5

Avg

. cum

ulat

ive

FF ta

rget

cha

nge

-.1 -.05 0 .05 .1Avg. intermeeting excess return, by own quintile

32

Superimposing the average 24‐hour pre‐FOMC return from days ‐1 and 0 of cycle N:

24‐hours pre‐FOMC returns have exactly the opposite put‐relation to past stock returns as do the subsequent target changes, suggesting that they are partly driven by unexpected Fed accommodation to bad past stock returns.

.002

.004

.006

.008

.01

.012

Avg

. 24

hour

pre

-FO

MC

retu

rn

-1.5

-1-.5

0.5

Avg

. cum

ulat

ive

FF ta

rget

cha

nge

-.1 -.05 0 .05 .1Avg. intermeeting excess return, by own quintile

Avg. cumulative FF target changeAvg. 24 hour pre-FOMC return

33

Table 8. Impulse response of Federal funds target to an intermeeting excess return in the lowest quintile, 1994‐2008 Daily data for all 176 day zeros are sorted into five buckets based on quintiles of the intermeeting excess return. Then focus on data for 1994‐2008. Show how excess return in the lowest quintile affects the Federal funds target over cycle C and the next 7 cycles.

Dependent variable: (Federal funds target on day 0 of cycle C+X) ‐(Federal fund target on day 0 of cycle C‐1)

X=0 X=1 X=2 X=3 X=4 X=5 X=6 X=7 Dummy for intermeeting excess return being in quintile 1 ‐0.149 ‐0.424** ‐0.585*** ‐0.791*** ‐0.926*** ‐1.004*** ‐1.123** ‐1.198**

[‐1.65] [‐2.87] [‐3.56] [‐3.99] [‐3.79] [‐3.54] [‐3.28] [‐3.06] Constant 0.0109 0.0489 0.0584 0.072 0.0693 0.0489 0.038 0.0109

[0.41] [0.87] [0.58] [0.49] [0.36] [0.20] [0.13] [0.03] Observations (FOMC cycles) 120 120 120 120 120 120 120 120 Note: Newey‐West t‐statistics allowing for autocorrelation up to X lags.

34

Moving to monthly data to control for expectations from Federal funds futures:

Actual change:

(Avg. realized daily FF target during month m+X)‐(FF target, end of month m‐2)

Expected change:

(FF futures for month m+X as of end of month m‐2)‐(FF target, end of month m‐2).

Unexpected change: (Actual change)‐(Expected change) For each of these three variables we calculate averages based on quintiles of the realized excess stock return over months m‐2 and m‐1.

Longest Fed funds futures with good data is the 8‐month contract.

35

-1-.5

0.5

1 2 3 4 5Avg. 2 month lagged excess return, by own quintile

Avg. expected changeAvg. actual change

Avg. expected change and avg. actual change

-.8-.6

-.4-.2

0

1 2 3 4 5Avg. 2 month lagged excess return, by own quintile

Avg. unexpected change

36

5) Intermeeting target changes tend to be in even weeks

Since 1994, Fed has mainly changed federal funds target at scheduled FOMC meetings: Only 7 of 61 changes over 1994‐2015 were between meetings.

This differs from pre‐1994 period:

From 1982:09 to 1993: 94 target rate changes, about 2/3 between meetings. So for pre‐1994 period we can better use target change dates to learn about when information processing/decision making happens within the Fed.

37

Probability of a federal funds target change on one of day t to t+4

-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5

-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4

-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3

-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2

-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-100000000000000000000000000000000000000000000000000000000000000000000000000000000000000000001111111111111111111111111111111111111111111111111111111111111111111111111111111111111111111

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rob.

of F

F ta

rget

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nge

over

day

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-10 0 10 20 30cycle

1982:9-1993

-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-6-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5-5

-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-4-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-3-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-2-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-100000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000

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38

6 of 7 federal funds target changes after 1994 were on the bi‐weekly FOMC cycle (and followed low stock returns)

Date of intermeeting

change in Federal funds target

Federal funds target change

Date in cycle Date of prior board meeting

FOMC conference call

10/8/2008 ‐0.5 16 1 day before 1 day before

1/22/2008 ‐0.75 ‐6 (30 of last cycle) 1 day before 1 day before

9/17/2001 ‐0.5 19 Same day Same day

4/18/2001 ‐0.5 21 Same day, 2 days before Same day

1/3/2001 ‐0.5 11 1 day before Same day 10/15/1998 ‐0.25 12 1 day before Same day 4/18/1994 0.25 19 Same day Same day

39

Date of intermeeting change in

Federal funds target

Cumulative excess return (pct)

since day 0 of: Quintile of cumulative excess

return (1=lowest) since day 0 of:

Cycle C (this cycle)

Cycle C‐1

Cycle C‐2

Cycle C‐3

Cycle C‐4

Cycle C (this cycle)

Cycle C‐1

Cycle C‐2

Cycle C‐3

Cycle C‐4

10/8/2008 ‐18.2 ‐21.4 ‐25.0 ‐28.2 ‐21.6 1 1 1 1 1 1/22/2008 ‐13.9 ‐14.6 ‐10.8 ‐10.0 ‐12.7 1 1 1 1 1 9/17/2001 ‐11.6 ‐14.8 ‐16.7 ‐10.6 ‐24.6 1 1 1 1 1 4/18/2001 5.3 ‐11.2 ‐7.1 ‐12.1 ‐16.6 5 1 1 1 1 1/3/2001 1.5 ‐4.0 ‐8.9 ‐11.8 ‐8.6 4 1 1 1 1

10/15/1998 ‐1.7 ‐6.1 ‐11.1 ‐9.4 ‐8.6 1 1 1 1 1 4/18/1994 ‐6.3 ‐7.8 ‐4.1 ‐3.9 ‐1.7 1 1 1 1 2

40

6) Board of Governors board meetings appear to lead the bi‐weekly return pattern

What happens at the board meetings?

‐ Briefings by Fed staff. The staff makes presentations about the latest economic and financial developments.

‐ Consideration of discount rate requests from regional Feds. Each regional fed’s board/executive committee meet to decide on discount rate recommendations. This happens by law at least every 2 weeks.

There’s always a Board of Gov’s board meeting to discuss these requests on one of the days just before an FOMC meeting. It takes two weeks for the Board of Governors to receive a full set of updated requests.

Larry Meyer (2004): “While the Reserve Bank presidents are not part of the premeeting discussions at the Board, they have their own devices for influencing the policy discussion in between meetings. They do this specifically through requests to change the discount rate.”

41

The bi‐weekly return pattern is disproportionately driven by observations that follow a board meeting (that’s about 1/3 of the data).

This suggests that Board meeting content in meetings going into even weeks is different than in meetings going into odd weeks.

One former Fed official has confirmed that not all board meetings contain detailed discussion of discount rate requests.

42

Decomposing main result into contributions from observations that follow or do not follow a Board of Governors board meeting, 1994‐2015

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06


Contribution from obs's with board meeting on one of prior 5 daysContribution from obs's without board meeting on one of prior 5 days

Contribution to average 5-day returns

43

Dependent variable: Daily excess return on stocks

(1) (2) Dummy=1 in Week 0 0.138***

(3.00)Dummy=1 in Week 2 0.083*

(1.88)Dummy=1 in Week 4 0.117**

(2.37)Dummy=1 in Week 6 0.201**

(2.21)(Dummy=1 in Week 0)*(Dummy=1 if t‐5 to t‐1 had board meeting) 0.177***

(3.52)(Dummy=1 in Week 2)*(Dummy=1 if t‐5 to t‐1 had board meeting) 0.182***

(3.13)(Dummy=1 in Week 4)*(Dummy=1 if t‐5 to t‐1 had board meeting) 0.156**

(2.41)(Dummy=1 in Week 6)*(Dummy=1 if t‐5 to t‐1 had board meeting) 0.166

(1.47)(Dummy=1 in Week 0,2,4,6)*(Dummy=1 if t‐5 to t‐1 had no board meeting) 0.037

(0.71)(Dummy=1 in Week ‐1,1,3,5)*(Dummy=1 if t‐5 to t‐1 had board meeting) 0.032

(0.79)Constant ‐0.024 ‐0.038

(‐1.17) (‐1.34) N (days) 5736 5736

44

The following two issues help explain the importance of the board meetings as the place information is generated:

1) The FOMC meetings have transcripts, the board meetings don’t. 2) The Government in the Sunshine Act is followed carefully (thought Fed is not legally mandate to comply). It implies that four or more Board/FOMC members may not meet to discuss policy without advance notice that a meeting will take place.

Former governor Kevin Warsh states:

45

In summary: The FOMC cycle in stock returns is likely to reflect news about monetary policy coming from the Federal Reserve:

1) The FOMC calendar is quite irregular and changes across sub‐periods over which our finding is robust.

2) Even weeks in FOMC cycle time do not line up with other macro releases or with reserve maintenance periods.

3) Volatility in fed funds market (but not to the same extent in other markets) peaks during even weeks in FOMC cycle time.

4) The Fed put shows up in both target changes and even‐week mean‐reversion

5) Intermeeting target changes tend to be in even weeks.

6) The bi‐weekly return pattern is disproportionately driven by observations that follow a board meeting

46

POSSIBLE MECHANISMS FOR HOW INFORMATION GETS FROM THE FEDERAL RESERVE TO ASSET MARKETS

a) Signaling via open market operations? No. Might the Fed have continued to communicate with the market via open market operations in the post‐1994 period?

We have spoken with senior Federal Reserve officials who inform us that no such signaling via OMOs happens.

47

b) Public information releases and public speeches by Federal Reserve officials? No: Some line up with week 4 in FOMC cycle time, but not week 0, 2, 6, and no excess return for these in general. FOMC statement: Doesn’t explain high week 0 returns. Released publicly just after FOMC meeting, typically around 2.15pm. But as shown by Lucca and Moench (2013) the return in week 0 in FOMC cycle time is earned prior to the FOMC statement.

Beigebook: Summarizes economic conditions across the 12 regional fed districts. Made public 2 weeks prior to each scheduled FOMC meeting.

Minutes of FOMC meetings: Before Dec 2004, released on avg. 47 days after meeting (i.e. after next FOMC meeting). Since Dec 2004 released on average 21 days after the meeting.

Minutes of Board of Governors discount rate meetings: Released in bunches 8 times per year, around 4 weeks after the FOMC meeting.

Green/Blue/Teal books and FOMC transcripts: Not public until 5 years later.

48

Releases of Federal Reserve documents over the FOMC cycle, 1994‐2015

Public releases

Beigebook and DR minutes line up with week 4 in FOMC cycle time. But not significant in excess return regression.

FOMC minutes don’t line up with even week returns (remember that week 0 return is earned before the announcement on day 0).

49

Speeches by Federal Reserve officials over the FOMC cycle

Only governor speeches are significant in excess return regression.

50

Regressions of daily excess stock returns on FOMC cycle dummies with controls for public Fed releases and speeches, 1994‐2015

(1)

Baseline (2)

Dummy=1 in Week 0 0.138*** 0.146*** (3.00) (3.09) Dummy=1 in Week 2 0.0829* 0.0818*

(1.88) (1.85) Dummy=1 in Week 4 0.117** 0.120** (2.37) (2.35) Dummy=1 in Week 6 0.201** 0.185**

(2.21) (2.01) Controls for public Fed monetary policy releases: Dummy for Beige book release on day t 0.0827 (0.87) Dummy for FOMC minutes release on day t ‐0.0921

(‐1.01) Dummy for discount rate meeting ‐0.121 minutes release on day t (‐1.16) Constant ‐0.0238 ‐0.0220

(‐1.17) (‐1.07) N (days) 5736 5736

51

(1) Baseline (3)

Dummy=1 in Week 0 0.138*** 0.133*** (3.00) (2.66)Dummy=1 in Week 2 0.0829* 0.082*

(1.88) (1.73)Dummy=1 in Week 4 0.117** 0.107** (2.37) (1.97)Dummy=1 in Week 6 0.201** 0.180**

(2.21) (1.98)Controls for speeches by Fed officials:Dummy for Governor speech on day t 0.0872*

(1.70)Dummy for Vice Chair speech on day t ‐0.0528

(‐0.52)Dummy for Chair speech on day t 0.00206

(0.03)Dummy for President speech on day t ‐0.0452

(‐1.18)Dummy for Governor speech on day t‐1 ‐0.00458

(‐0.09)Dummy for Vice Chair speech on day t‐1 0.0274

(0.28)Dummy for Chair speech on day t‐1 ‐0.0511

(‐0.80)Dummy for President speech on day t‐1 0.0107

(0.29)Constant ‐0.0238 ‐0.0186

(‐1.17) (‐0.77)N (days) 5736 5736

52

c) Systematic informal communication from the Fed to the media and the financial sector

We next provide evidence that the Fed had, and continues to have, systematic informal communication with reporters and the financial sector. Approaches: 1) Examples of informal communication of board meeting information Examples of informal communication of FOMC outcome and FOMC minutes

2) Document Fed motives for informal communication based on statements made by current and former Fed officials and market participants.

3) Two tests of whether we have the right framework for informal communication.

53

Examples of informal communication of board meeting information:

Media or Newsletter content in the public domain

Private discussions at the Fed Board Meeting

1

Wessel, David. Wall Street Journal, June 19, 1995

Discount Rate Minutes, June 19, 1995

"In speeches and interviews; the outspoken Mr. Blinder has made it clear he is increasingly worried…. Two other Fed governors; fellow Clinton appointee Janet Yellen and Bush appointment Lawrence Lindsey; are said to be ready to cut interest rates; too. All three supported the round of interest‐rate increases that ended four‐and‐a‐half months ago."

"Vice Chairman Blinder believed that the requests for a reduction in the discount rate had merit...Governor Lindsey stated …, in his view, this outlook for a relatively weak economy called for a reduction in the overall structure of interest rates. Governor Yellen believed that the inflation risk had moderated and that economic conditions warranted a monetary easing action."

8 such examples in paper, 5 to reporters, 3 to financial sector (newsletter writers, including former governor Meyer).

54

Bernanke in his new book lists his most used reporters as (in order): Jon Hilsenrath (WSJ), Greg Ip (Economist), Krishna Guha (FT), Neil Irwin (Wash Post), John Berry (Bloomberg), Steve Liesman (CNBC), Ed Andrews (NYT).

Former Fed Governor Meyer (2004) writes:

“The use of reporters as part of the Fed’s signal corps is not official Board or FOMC doctrine. The public affairs staff and the Chairman like to pretend it doesn’t happen… John Berry, longtime reporter for The Washington Post and now at Bloomberg is the more widely recognized in this role. But The Wall Street Journal reporter covering the Fed – it was David Wessel, then Jake Schlesinger, and most recently Greg Ip during my term – was also a regular member of the signal corp.” (pg 98) “I was surprised, then, one Monday before an FOMC meeting, to pass John Berry coming out of the Chairman’s office.” (pg 99)

55

Prior to our 1994‐2015 sample period there is additional direct evidence of systematic leaks from the Fed to the Wall Street Journal.

From 1989 to May 1993 on 11 occasions, the essence of the FOMC directive to the open market operations desk was leaked the WSJ within one week of the meeting prior to its public release.

Most famous articles in this series of leaks were stories by David Wessel.

Led to Fed’s concessions to release its fed funds target decision publicly right after the FOMC meeting and to make transcripts of FOMC meetings available, albeit with a 5‐year lag.

56

Wall Street Journal articles by David Wessel, 1994‐2013

Based on articles in the WSJ from 1994‐2013 by David Wessel which contains any of the words “FOMC” or “federal open market committee”or “fed board”.

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Probability of article on day t,...,t+4Articles on day after FOMC or minutes releases excluded

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Examples of informal communication of FOMC outcome and FOMC minutes:

1 FOMC Transcript August 16, 2007 “MR. LACKER. Vice Chairman Geithner, did you say that [the banks] are unaware of what

we’re considering or what we might be doing with the discount rate? VICE CHAIRMAN GEITHNER. Yes. MR. LACKER. Vice Chairman Geithner, I spoke with Ken Lewis, President and CEO of Bank of America, this afternoon, and he said that he appreciated what Tim Geithner was arranging by way of changes in the discount facility. So my information is different from that.”

2 Interview of Bill Gross, PIMCO, on CNBC. Reported by Taibbi, Matt, The Rolling Stone. October 8, 2010

“A hilarious example of this cozy insiderism popped up just a few weeks ago, when PIMCO bond fund chief Bill Gross let it slip on a live CNBC interview that he was getting inside info from the Fed. The interview is with former Goldman analyst and (now) CNBC anchor Erin Burnett, as well as… Steve Liesman... Gross at one point says this: `What is important going into November is the staff forecast for economic growth for the next 12‐18 months. Our understanding is that the Fed is about to downgrade their forecast from 3% down to 2%. Which in turn would suggest that unemployment won't be coming down… and so that would be the trigger to my way of thinking for Quantitative Easing in November.’ The admission is so untoward that the ex‐Goldmanite Burnett immediately races to clean up the problem, saying to Liesman, who is also on the panel, ‘We don't have that forecast yet, right, Steve?’ At which point [Liesman] replies, `We won't get that for 3 weeks, Erin. That's when it comes out with the minutes of this meeting.’”

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3 Newsletter, Laurence Meyer, Founder & Senior Managing Director, Macroeconomic AdvisersReported by Cooke, Kristina, Pedro da Costa and Emily Flitter. Reuters, September 30, 2010

“On August 19, just nine days after the U.S. central bank surprised financial markets by deciding to buy more bonds to support a flagging economy, former Fed governor Larry Meyer sent a note to clients of his consulting firm with a breakdown of the policy‐setting meeting. The minutes from that same gathering of the powerful Federal Open Market Committee, or FOMC, are made available to the public ‐‐ but only after a three‐week lag. So Meyer's clients were provided with a glimpse into what the Fed was thinking well ahead of other investors.” [Later in the article, concerning former Fed employees and outsiders:] “Fed board staffers who retire even get to keep their pass for the central bank's building, which boasts fitness facilities, a barber and a dining room… they are not restricted to where they can go once inside the building.”

4 Calls by Nancy Lazar to clients, International Strategy & Investment, August 15, 2011Reported by Pullman, Susan. Wall Street Journal, November 22, 2011.

“Hours after an Aug. 15 meeting with Federal Reserve Chairman Ben Bernanke in his office, Nancy Lazar made a hasty call to investor clients: The Fed was dusting off an obscure 1960s‐era strategy known as Operation Twist…Ms. Lazar is among a group of well‐connected investors and analysts with access to top Federal Reserve officials who give them a chance at early clues to the central bank's next policy moves; according to interviews and hundreds of pages of documents obtained by The Wall Street Journal through open records searches.”

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5 Advice to clients, Wayne Angell, Bear, Stearns & Co. Reported by Wessel, David. Wall Street Journal, July 7, 1995

"One Fed watcher who called it right ‐‐ barely ‐‐ was former Fed governor Wayne Angell; now an economist at Bear; Stearns & Co. Mr. Angell had been among those confidently predicting that the Fed would hold rates steady at this week's meeting. But on Wednesday ‐‐ after joining current Fed officials and others the night before to watch Fourth of July fireworks from the roof of the Fed's building in Washington ‐‐ Mr. Angell abruptly announced that he had changed his view and anticipated a one‐quarter‐point cut. Mr. Angell said he changed his mind while riding a bike on Tuesday before going to the fireworks."

6 Leak of FOMC minutes and additional FOMC detail to Medley Global Advisors, Oct 3, 2012

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Item 6 (Medley Global Advisors) has resulted in an ongoing investigation.

1) After the leak emerged, Congress demanded a list of Fed employees with whom MGA had contact. Chair Yellen has herself met with Medley on multiple occasions, but not during the leak period. One current staff told us that the list has many names and that one of that staff’s job assignments was regular conversations with Medley.

2) The Financial Times owns MGA and their First Amendment defense of MGA being a newspaper seems tenuous. I could not get a subscription quote without telling MGA who I am. The price is $120K/year. They generously offered me $24K.

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Understanding the motives helps make it plausible that informal communication is systematic and motives are central for assessing the use of informal communication from a social welfare perspective. Three reasons emerge. 1) Flexibility: Informal communication does not bind policy makers’ hands

The lack of flexibility caused by public statements appears to result from: 1) The difficulty of making a sufficiently state‐dependent projection about policy. 2) Fed concern about having market impact or being perceived as such. Ex‐governor Stein to the WSJ: “To avoid unsettling markets, he [Stein] said, Fed officials have an incentive to stick to the path investors infer.” Stein and Sundaram (2015) assume that the Fed is averse to bond‐market volatility. They argue that this aversion is counter‐productive. Society would be better off with a Fed who cares less about the market.

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Greenspan expressed this motive in response to congressional pressure for more public communication from the Fed in the years surrounding the 1989‐1993 leaks. […] Earlier release of the Directive would […] force the Committee itself to focus on the market impact of the announcement as well as on the ultimate economic impact of its actions. To avoid premature market reaction to mere contingencies, FOMC decisions could well lose their conditional character. Given the uncertainties in economic forecasts and in the links between monetary policy actions and economic outcomes, such an impairment of flexibility in the evolution of policy would be undesirable.”

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2) Learning: Informal communication facilitates Fed learning Fed get to compare its assessment of the economy to that of the private sector.

Getting a sense of how the market would react to a given policy move. Operating Twist (Maturity Extension Program) leak is an example of this.

A WSJ article by Susan Pullman, 11/22/2011, quotes Blackrock CEO Laurence Fink to explain the Fed’s desire to learn from the private sector:

“ "It's like an inquisition; they have a topic;" said Laurence Fink; chief executive of investment‐management giant BlackRock Inc. "By the questions they ask; by definition; you know what's on their mind.” “

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3) Disagreement: Fed informal communication is an equilibrium outcome of disagreements among FOMC members

Several current and former officials have emphasized the need to set the record straight by communicating with the media and with those writing influential newsletters.

An investigation into the sources behind a particularly detailed WSJ article by Jon Hilsenrath on 9/28/2012 found that “its author had talked, in some cases multiple times, with every Reserve Bank president and most members of the Board of Governors. He had also spoken to a number of staff members.”

If one FOMC member succeeded in representing his or her view as that of the Fed and markets reacted accordingly, the Fed would be compelled to do as the market incorrectly expected. To avoid this outcome, FOMC members have an incentive to all talk to the same members of the press and the same newsletter writers.

One former official told us that the pre‐FOMC effect may result from competing leaks by insiders trying to influence the public interpretation of the FOMC statement. By necessity such leaks would need to come before the statement.

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These motives are surprisingly similar to the motives for leaks from other parts of the US government documented by Pozen (2013).

‐ Disagreement‐driven leaks: Called “internecine leaks” and “counter‐leaks”: “Significant subtypes of the policy leak might include the internecine leak through which competing agencies or factions within the executive branch strive to strengthen their relative positions, and the counter‐leak, intended to neutralize or dispute prior disclosures”.

‐ Learned‐driven leaks: Called “trial‐balloon leaks”, “meant to test the response of key constituencies”.

‐ Flexibility: Pozen argues that executive branch interests are served by leakiness: “These interests include preserving ambiguity as to the origins of unattributed disclosures and therefore the communicative flexibility of top officials”.

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Two tests of whether we have the right framework for leaks: 1) If the Fed values flexibility, it should make fewer changes to the target post‐1994, because changes necessitate public statements.

The fraction of target changes that happen between FOMC meetings drops discretely in 1994 from a mean of 65% for 1982:9‐1993 to a mean of 11% for 1994‐2015. 2) If pre‐FOMC effect results from competing leaks prior to the FOMC statement, then the pre‐FOMC effect should not be present pre‐1994, and policy news should instead come after after the end of the FOMC meeting.

Excess returns Sample 1982:9‐1993 1994‐2015 (1) Avg. excess return from open on day ‐1 0.447** 0.605*** to close on day 3 (2.01) (3.46) (2) Avg. excess return from open on day ‐1 0.0621 0.509*** to before the announcement on day 0 (0.43) (5.17) (3) Avg. excess return from the announce‐ 0.390** 0.0963 ment on day 0 to close on day 3 (2.00) (0.66) N 91 176

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POLICY IMPLICATIONS

Informal communication to facilitate learning may require informal communication. But this should be done very carefully. A former Fed official put it like this: “Talking to people poses a tradeoff between potentially conveying an information advantage to a subset of the public against refining the outside understanding of policy and improving the inside view of the economy.“

The Fed should come to terms with the fact that it drives the market. A Fed less concerned with looking like it doesn’t move markets would:

Not lose flexibility by using public rather than informal communication Not be in a Nash equilibrium of informal communication

Documents

Stock returns over the FOMC cycle - Berkeley Haasfaculty.haas.berkeley.edu/vissing/cycle_slides.pdf2 OUR NEW FACT From 1994‐2015 the US equity premium Follows an alternating weekly