The impact of the Federal Reserve Bank's open market operations

Abstract

The Federal Reserve Bank has the ability to change the money supply and to shape the expectations of market participants through their open market operations. These operations may amount to 20% of the day's volume and are concentrated during the half hour known as “Fed Time”. Using previously unavailable data on open market operations from 1982 to 1988, our paper provides the first comprehensive examination of the impact of the Federal Reserve Bank's trading on both fixed income instruments and foreign currencies. Our results detail a dramatic increase in volatility during Fed Time, consistent with market expectations of Fed intervention during this time interval. We find that there is little systematic difference in market impact between reserve-draining and reserve-adding operations. Additionally, Fed Time volatility is, on average, higher on days when open market operations are absent. These results suggest that the markets are potentially confused about the purpose of the open market operations during our sample period. The evidence is also consistent with the Fed operations conveying information which smooths market participants’ expectations.