FOMC Announcements and Predictable Returns

Abstract

Existing literature associates FOMC meetings with abnormally high market returns and good performance of the CAPM. I show that both effects are concentrated on meetings with surprise cuts to the Fed funds target rate. Moreover, stocks that perform poorly around meetings with surprise rate cuts subsequently outperform the market. This behavior generates robust predictability in the cross section of monthly stock returns. Stocks whose returns have positive covariances with surprise changes to the Fed funds target rate carry a significant premium in their future returns. These covariances, however, are transient, indicating short-lived interest rate exposure for individual firms. The evidence is difficult to reconcile with equilibrium risk pricing of short-term interest rate shocks in the cross section of stock returns.