Federal Open Market Committee Meetings Research Articles

Target rate factors in short rate models

This study investigates the risk associated with the uncertainties in the central bank monetary policy targets in the context of short interest rate models. A class of models is proposed which admits two channels of interest rate risk. In a prototypical case, the short duration channel handles the uncertainties in the target rates decided in the forthcoming Federal Open Market Committee meetings. The target rate factors can be calibrated on the market values of the Fed funds futures. The long duration channel has traditional risk factors. The episodes following the Covid-19 outbreak and the 2022 rate hikes are used as examples in an empirical study.

The Voice of Monetary Policy

We develop a deep learning model to detect emotions embedded in press conferences after the Federal Open Market Committee meetings and examine the influence of the detected emotions on financial markets. We find that, after controlling for the Federal Reserve’s actions and the sentiment in policy texts, a positive tone in the voices of Federal Reserve chairs leads to significant increases in share prices. Other financial variables also respond to vocal cues from the chairs. Hence, how policy messages are communicated can move the financial market. Our results provide implications for improving the effectiveness of central bank communications. (JEL D83, E31, E44, E52, E58, F31, G14)

THE POWER OF THE FEDERAL RESERVE CHAIR

AbstractThis article examines the influence exerted by the Federal Reserve chair on monetary policy decisions. We construct a voting model where the chair selects the proposal that is initially put to a vote but is subject to an acceptance constraint that incorporates the preferences of the median Federal Open Market Committee (FOMC) member and the probability of counterproposals. The model is estimated by maximum likelihood using real‐time data from FOMC meetings. Results for all chairs in our sample show that the chair's proposal is the result of a compromise, reflecting a stable balance of power within the FOMC.

Monetary Policy Communications and Their Effects on Household Inflation Expectations

We study how different forms of communication influence the inflation expectations of individuals in a randomized controlled trial. We first solicit individuals’ inflation expectations in the Nielsen Homescan panel and then provide eight different forms of information regarding inflation. Reading the actual Federal Open Market Committee (FOMC) statement has about the same average effect on expectations as simply being told about the Federal Reserve’s inflation target. Reading a news article about the most recent FOMC meetings results in a forecast revision which is smaller by half. Our results have implications for how central banks should communicate to the broader public.

Forward Guidance and Corporate Lending

Abstract We suggest that forward guidance, via publicly committing the central bank to future actions and creating associated expectations, fundamentally affects bank lending decisions independently of other forms of monetary policy. To test this hypothesis, we build a forward guidance measure based on the language used in the Federal Open Market Committee meetings and match this measure with syndicated loans. Our results show that expansionary forward guidance decreases corporate loan spreads and that this effect is stronger for well-capitalized banks lending to riskier firms. Forward guidance also affects nonprice lending terms, such as covenants, performance pricing provisions, and the loan syndicate structure. Additionally, banks tend to initiate new lending relationships with lower spreads after forward guidance issuance.

Institutional Trading around FOMC Meetings: Evidence of Fed Leaks

Using detailed institutional transaction records from Ancerno, I find evidence consistent with informed trading on the days before the Federal Open Market Committee (FOMC) scheduled announcements. The institutional trading imbalances on highly exposed stocks are in the direction of the subsequent monetary policy surprises. On the three days before a 1% surprise rate increase, the institutional trading imbalance is 27.7% higher for high-MPE stocks as compared to low-MPE stocks. This result is particularly strong before easing monetary policy shocks - when the aggregate market reaction is positive -, for the most-active traders and the hedge fund management companies, and for the US institutions that are headquartered close to one of the regional reserve banks. It holds throughout the Ancerno's sample, from 1999 to 2014. Overall, these findings are consistent with a hypothesis of a systematic informal communication of Fed officials with the financial sector, provide an additional channel through which institutions make abnormal profits from their intra-quarter trades, and contribute to an information-based explanation of the pre-FOMC drift.

Forward Guidance and Corporate Lending

We suggest that forward guidance, via publicly committing the central bank to future actions and creating associated expectations, fundamentally affects bank lending decisions independently of other forms of monetary policy. To test this hypothesis, we build a forward guidance measure based on the language used in the Federal Open Market Committee meetings and match this measure with syndicated loans. Our results show that expansionary forward guidance decreases corporate loan spreads and that this effect is stronger for well-capitalized banks lending to riskier firms. Forward guidance also affects nonprice lending terms, such as covenants, performance pricing provisions, and the loan syndicate structure. Additionally, banks tend to initiate new lending relationships with lower spreads after forward guidance issuance.

Restoring the Promise of Federal Reserve Governance

The US Federal Reserve System (Fed) is famous for its organizational complexity. Overlooked in debates about the costs and benefits of this complexity for the Fed’s legitimacy, independence, and accountability is the congressional vision of what the Fed should be. The central bank is governed by a highly accountable seven-person Board of Governors to manage the rest of the system. Time and experience have eroded this authority as a matter of practice but not as a matter of law. The Fed governors are supposed to supervise the system, a legal aspiration that has increasingly been enervated by institutional drift. Using empirical and historical tools, this paper discusses the erosion of the Board of Governors over the Fed’s century-long history, including the substantial reduction in real compensation for the governors, their diminished participation in Federal Open Market Committee (FOMC) meetings, and the increased vacancies that recently have been driven by the political process. To address these problems, the paper suggests reforms across three divides: cultural, regulatory, and legislative. Remedies include changing norms of FOMC meeting participation to place nonvoting members of the FOMC as “observers”; clarifying the role of the Fed’s Board of Governors in supervising the Federal Reserve Banks, particularly with respect to the presidential search process; increasing attention to vacancies and promoting bipartisan interest in credible candidates; and increasing governor salaries to match those of their colleagues at the 12 Federal Reserve Banks, consistent with legislative intent from 1913.

Measuring discourse by algorithm

Scholars increasingly use machine learning techniques such as Latent Dirichlet Allocation (LDA) to reduce the dimensionality of textual data and to study discourse in collective bodies. However, measures of discourse based on algorithmic results typically have no intuitive meaning or obvious relationship to humanly observed discourse. Such measures of discourse must be carefully validated before relied on and interpreted. We examine several common measures of discourse based on algorithmic results, and propose a number of ways to validate them in the setting of Federal Open Market Committee meetings. We also suggest that validation techniques may be used as a principled approach to model selection and parameterization.

Composite Seasonal Equity Trading Strategy

The main focus of this paper is to show that calendar/seasonal anomalies are well-working even in the most recent periods and, additionally, to find a way how to combine them in a search for profit from the practitioner's point of view. This paper is a case study of possible usage of following anomalies: Turn of the Month in Equity Indexes, Federal Open Market Committee Meeting Effect in Stocks, Option-Expiration Week Effect and The Payday Effect. Firstly, it was found that each individual trading strategy is profitable and those strategies could or probably should be combined into one complex composite seasonal strategy. The analysis has also found that the strategy mentioned above could be enhanced by the addition of a trend factor. To be more precise, data suggest that it is worth to systematically trade only if the trend factor signals to do that. Such addition drastically reduces drawdowns and the resulting strategy simply does not enter into trading positions when the market situation is not favorable.

Measuring Discourse by Algorithm

Scholars increasingly use machine learning techniques such as Latent Dirichlet Allocation (LDA) to reduce the dimensionality of textual data and to study discourse in collective bodies. However, measures of discourse based on algorithmic results typically have no intuitive meaning or obvious relationship to humanly observed discourse. Such measures of discourse must be carefully validated before relied on and interpreted. We examine several common measures of discourse based on algorithmic results, and propose a number of ways to validate them in the setting of Federal Open Market Committee meetings. We also suggest that validation techniques may be used as a principled approach to model selection and parameterization.

Comment on “Central Bank announcements: Big news for little people?” by Michael Lamla and Dmitri Vinogradov

Lamla and Vinogradov study the causal effect of central bank announcements on consumers' expectations and perceptions by conducting a new series of surveys. I discuss the key empirical results of the paper, supplement their results with evidence of news coverage patternssurrounding Federal Open Market Committee meetings, and provide suggestions for future research using the authors' novel dataset.

The impact of monetary policy on option-implied stock market expectations

PurposeThe purpose of this paper is to investigate the impact of Federal Open Market Committee (FOMC) meetings and the changes of the target rates on stock market uncertainty.Design/methodology/approachMultivariate regression analysis is applied to the historical data of VIX, FOMC meetings and target rates. Subtle relations are revealed by further categorizing the FOMC meetings into being scheduled and unscheduled and distinguishing the signs of the changes in VIX and target rates. CPI and the prime rate are used for robustness test.FindingsThe authors first examine the relation between FOMC meetings and target surprises; the results indicate that unscheduled FOMC meetings heavily impact the target surprises. Then, the authors investigate the relation between FOMC meetings and VIX changes; the results show that both unscheduled and scheduled FOMC meetings impact VIX, where the impacts of scheduled FOMC meetings are more substantial. The authors also analyze the responses of VIX to the target surprises, and the results reveal that there is an asymmetric effect of target surprises on VIX, where the influences of the scheduled positive target surprises are more significant. Finally, by examining the relation between the FOMC meeting and the risk-neutral density of the VIX option, the authors conclude that both KURT and SKEW are more affected by unscheduled FOMC meetings.Originality/valueDeeper dimensions of the relations between VIX, FOMC meetings and target rates are analyzed and more insightful understandings of such relations are gained.

The Wisdom of Twitter Crowds: Predicting Stock Market Reactions to FOMC Meetings via Twitter Feeds

With the rise of social media, investors have a new tool to measure sentiment in real time. However, the nature of these sources of data raises serious questions about its quality. Since anyone on social media can participate in a conversation about markets -- whether they are informed or not -- it is possible that this data may have very little information about future asset prices. In this paper, we show that this is not the case by analyzing a recurring event that has a high impact on asset prices: Federal Open Market Committee (FOMC) meetings. We exploit a new dataset of tweets referencing the Federal Reserve and shows that the content of tweets can be used to predict future returns, even after controlling for common asset pricing factors. To gauge the economic magnitude of these predictions, the authors construct a simple hypothetical trading strategy based on this data. They find that a tweet-based asset-allocation strategy outperforms several benchmarks, including a strategy that buys and holds a market index as well as a comparable dynamic asset allocation strategy that does not use Twitter information.

Channels of US monetary policy spillovers to international bond markets

We show significant US monetary policy (MP) spillovers to international bond markets. Our methodology identifies US MP shocks as the change in short-term Treasury yields around Federal Open Market Committee meetings and traces their effects on international bond yields using panel regressions. We emphasize three main results. First, US MP spillovers to long-term yields have increased substantially after the 2007–2009 global financial crisis. Second, spillovers are large compared with the effects of other events, and at least as large as the effects of domestic MP after 2008. Third, spillovers work through different channels, concentrated in risk-neutral rates (expectations of future MP rates) for developed countries, but predominantly on term premia in emerging markets. In interpreting these findings, we provide evidence consistent with an exchange rate channel, according to which foreign central banks face a trade-off between narrowing MP rate differentials or experiencing currency movements against the US dollar. Developed countries adjust in a manner consistent with freely floating regimes, responding partially with risk-neutral rates and partially through currency adjustments. Instead, emerging countries display patterns consistent with foreign exchange interventions, which cushion the response of exchange rates but reinforce capital flows and their effects in bond yields through movements in term premia. Our results suggest that the endogenous effects of currency interventions on long-term yields should be added into the standard cost-benefit analysis of such policies.

The Pre-FOMC Announcement Drift: An Empirical Analysis

Previous research documented large positive abnormal returns in US equity markets during a 24-hour window immediately preceding Federal Open Market Committee (FOMC) meetings between 1994 and 2011. This anomaly was called the “pre-FOMC announcement drift.” This article examines whether this return pattern persisted beyond the original sample end date and whether it is observed in additional asset classes. The equity return during the pre-FOMC window declined from 0.5% on average per FOMC meeting to roughly 0.1% in the out-of-sample period after 2011 and was no longer significant. Furthermore, the authors find no evidence of a pre-FOMC announcement effect in US nominal and real interest rates (US Treasuries and Treasury Inflation-Protected Securities), currencies ($/euro, $/British pound, $/Japanese yen, and $/Swiss franc), precious metals (gold and silver), and commodities (oil, heating oil, and natural gas). Results indicate that the pre-FOMC announcement drift was limited to equity markets and weakened significantly post-2011, consistent with market participants taking advantage of the anomaly or with a time-varying effect. However, the fact that the effect weakened postsample, but prepublication, rather than postpublication, may suggest this dynamic was sample specific. <b>TOPICS:</b>Security analysis and valuation, performance measurement, statistical methods

Understanding the Aspects of Federal Reserve Forward Guidance

This paper studies the effects of Federal Open Market Committee (FOMC) forward guidance language. I estimate two policy surprises at FOMC meetings: a change in the current federal funds rate and an orthogonal change in the expected path of the federal funds rate. From February 2000 to June 2003, the FOMC only gave forward guidance about risks to the economic outlook, and a surprise increase in the expected federal funds rate path had expansionary effects. This is consistent with models of central bank information effects, where a positive economic outlook causes private agents to revise up their expectations for the economy. From August 2003 to May 2006, the FOMC also gave forward guidance about policy inclinations, and a surprise increase in the federal funds rate path had contractionary effects. These results are consistent with standard macroeconomic models of forward guidance. Overall, the effects of forward guidance depend on the FOMC’s choice to use one or both of the economic-outlook and policy-inclination aspects of forward guidance.

The Dollar Ahead of FOMC Target Rate Changes

I find that the U.S. dollar appreciates before contractionary monetary policy decisions at scheduled Federal Open Market Committee meetings and depreciates before expansionary decisions. The federal funds futures rate forecasts these dollar movements with a 22% R2. A high federal funds futures spread three days in advance of an FOMC meeting not only predicts the target rate rise, but also predicts a rise in the dollar over the subsequent two-day period. This predictability is concentrated in times of high FX volatility, as the FX traders avoid arbitrage risk earlier than a few days prior to the announcement.

The informational role of options markets: Evidence from FOMC announcements

Abstract This paper examines the informational role of equity options trading around Federal Open Market Committee (FOMC) announcements. We find that information contained in option trades prior to FOMC rate change announcements, measured as implied volatility spread, predicts bank stock returns to a greater degree than does volatility spread prior to non-meeting days. We examine U.S. banks due to their interest rate sensitivity; however, we also show that return predictability around rate changes is reliably stronger in all firms, across all industries that are more interest rate sensitive. We find that return predictability is primarily driven by surprise changes in interest rates that occur during meetings with high degrees of information asymmetry. Finally, we document that volatility spread impounds information about FOMC meetings before that information is reflected in stock prices; this effect is significantly greater during surprise events, suggesting that the options market is an important source of informed trading.

What Insights Do Taxi Rides Offer into Federal Reserve Leakage?

In this paper, I employ anonymous New York City yellow taxi records to infer variation in interactions between insiders of the Federal Reserve Bank of New York (New York Fed) and insiders of major commercial banks around Federal Open Market Committee (FOMC) meetings. Taxi rides between the vicinities of the New York Fed's and the major commercial banks' buildings serve as indicators of meetings at those institutions, and coincidental drop-offs of passengers picked up around those institutions serve as indicators of offsite meetings. Cieślak, Morse and Vissing-Jorgensen (2016) posit systematic leakage from the Federal Reserve around FOMC meetings along unofficial channels, and, in line with that hypothesis, I find highly statistically significant evidence of increases in meetings at the New York Fed late at night and in offsite meetings during typical lunch hours.