Target Rate Changes Research Articles

The Impact of Unexpected FOMC Actions on Corporate Earnings Expectations

This paper fills a gap in the literature by examining the impact of unexpected Federal Open Market Committee (FOMC) actions on the markets expectations of U.S. corporate earnings by examining the sell-side analysts' quarterly earnings forecasts from 1989 to 2022. This paper reveals a significant negative correlation between analysts' earnings forecasts and unexpected changes in the target interest rate. This correlation weakened after the Federal Reserves implementation of Forward Guidance as a monetary tool in 2004, which appears to enhance the market's ability to predict target rate adjustments. In addition, this paper shows that with a given amount of unexpected target rate changes, value firms display greater earnings forecast revisions from analysts than growth firms. Debt levels or profitability factors cannot fully explain this phenomenon. The findings of this paper contribute to the knowledge of how FOMC actions exert influence on equity valuations and the transmission mechanisms of monetary policies.

Domestic or U.S. News: What Drives Canadian Financial Markets?

Using a GARCH model, we study the effects of Canadian and U.S. central bank communication and macroeconomic news on Canadian bond, stock, and foreign exchange market returns and volatility. First, central bank communication and macro news from both countries have an impact on Canadian financial markets. Second, Canadian central bank communication is more relevant than its U.S. counterpart, whereas in the case of macro news, that originating from the United States dominates. Third, we find evidence that the impact of Canadian news reaches its maximum when the Canadian target rate departs from the Federal Funds target rate (2002–2004) and thereafter. The introduction of fixed announcement dates (FAD) initially does not cause a noticeable break in the data. Finally, Canadian and U.S. target rate changes lead to higher price volatility, and so does other U.S. news. Other Canadian news, however, lowers price volatility.

US monetary policy surprises transmission to European stock markets

This paper empirically investigates the impact of U.S. monetary policy surprises on the volatility of stock market returns for euro area countries. More specifically, to extract the unanticipated component of the U.S. monetary policy, we follow the Kuttner’s methodology and we use the federal funds futures. Using the approach of dynamic conditional correlation (DCC) as introduced by Engle (2002) over the period from January 01, 2004 through December 31, 2008, we find that U.S. monetary policy surprises exert a strong influence on market volatility. This confirms the efficient markets hypothesis demonstrating that equity prices should only react to new information. We also find a significant response of volatility to expected component of target rate change. We highlight homogeneity in the responsiveness of European stock markets to U.S. news announcements. It is important to note that the persistence of volatility is clear across all regressions and it is shown by the strongly significance of associated coefficients.

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 information content of an increase in federal funds rate from a zero lower bound environment

PurposeAfter a seven-year period of being stuck in the zero lower bound (ZLB) range, the target rate was raised by 25 basis points on December 16, 2015. Prior to the rate hike, the important issues that the Federal Reserve dealt with were the magnitude, timing, and the information conveyed by a first-time rate hike from the ZLB period. The purpose of this paper is to use the data from the ZLB period and simulate the impact of an increase in the proxies for the federal funds rate: effective federal funds rate and shadow rate, and measure the impact on the resulting changes in credit default swap (CDS) spreads across 11 industries. Increases in both proxies predict a significant decrease in CDS spreads which is indicative of an economic recovery. This prediction is confirmed by the announcement effect of the actual rate increase on December 16, 2015 and the three subsequent rate increases.Design/methodology/approachIn the absence of target rate changes in the ZLB environment, the authors use a recursive vector autoregressive (VAR) model to simulate the rate increases in proxies for target federal rate and predict the impact on the economy by observing the reaction in CDS spreads and stock returns across 11 industries.FindingsThe impulse response indicates that an increase of one standard deviation in the effective rate (approximately 25 basis points) results in a statistically significant decrease in the spreads of CDS contracts in 8 of the 11 sectors studied in this research. Similar results obtain for an increase in shadow rate thus providing a robustness check. These results suggest a rate increase from the ZLB period and the resulting dynamics captured in the VAR system is indicative of an economic recovery.Originality/valuePrior studies have used the event study methodology to evaluate the impact of rate changes on credit spreads. The ZLB environment does not contain data on target rate changes and renders the event study methodology as ineffective. This paper is the first to simulate the implications of a first-time rate increase from the ZLB environment in the context of a recursive VAR model. The results are very helpful to the Federal Reserve of countries experiencing a ZLB environment such as Japan and Europe.

U.S. Monetary Policy Surprises Transmission to European Stock Markets

This paper empirically investigates the impact of US monetary policy surprises on the volatility of stock market returns for euro area countries. More specifically, to extract the unanticipated component of the US monetary policy, we follow the Kuttner's methodology and we use the federal funds futures. Using the approach of dynamic conditional correlation (DCC) as introduced by Engle (2002) over the period from 1 January, 2004 through 31 December, 2008, we find that US monetary policy surprises exert a strong influence on market volatility. This confirms the efficient markets hypothesis demonstrating that equity prices should only react to new information. We also find a significant response of volatility to an expected component of target rate change. We highlight homogeneity in the responsiveness of European stock markets to US news announcements. It is important to note that the persistence of volatility is clear across all regressions and it is shown by the strong significance of associated coefficients.

Dichotomous stock market reaction to episodes of rules and discretion in the US monetary policy

We investigate the microeconomic effects of the monetary policy conduct in the United States by observing the response of the domestic capital market with respect to unexpected changes in the Fed Funds rate target in discretionary as opposed to rules-based policy eras. These dichotomous situations are identified by means of a model with structural breaks applied on the deviations of the effective Fed Funds target rate changes from the Taylor (1993) rule implied rate change. Employing an event-study analysis, we measure the response of the S&P500 index to unexpected Fed Funds rate changes, determined from comparison with the futures rates. We find strong evidence which suggests that the monetary policy based on rules spawns consistent rational stock market reactions, while a discretionary policy increases microeconomic uncertainty. We analyze the implications of this dichotomous effect at the level of the risk-taking monetary transmission channel and also provide evidence with respect to the accounts of a monetary policy based on forward rate guidance on the equity market.

Open Market Operation Effectiveness in China

ABSTRACTThis paper examines the effectiveness of target rate guidance in open market operation by the central bank in China (PBOC). We find that target rate change in open market operation is effective in adjusting the short-term Treasury rates. The target rate changing direction is more effective than the target rate changing level. There is no significant asymmetry in the effectiveness between the target rate increase and target rate decrease. We also document that the effectiveness of the target rate is conditional on liquidity operation of the same direction, especially when they both aim to loosen the monetary policy. Furthermore, consecutive operations with higher intensity appear to be more effective in adjusting the market interest rate.

The Impact of Monetary Surprises on Australian Financial Futures Markets: An Insight into Cash Rate Target Announcements

This paper investigates the impact of unanticipated Australian monetary policy changes on AUD/USD exchange rate futures, and 3-year and 10-year Australian Treasury bond futures, during the period from January 1997 to April 2010. Our study contributes to the literature by using both the 30-day and the 90-day bank accepted bill (BAB) rates to disentangle the unexpected surprise component of monetary policy changes from overall cash rate target changes in the Australian money market, and by concurrently modelling the effects of monetary surprises and other key macroeconomic announcements in Australia. The empirical results suggest that the 30-day BAB rate is the best proxy for the expected monetary policy actions. We find that the effect of monetary surprises on the volatility of the 3- and 10-year bond future instruments is significant and persistent. We have also documented a strong monetary policy effect on the mean returns of the exchange rate futures, indicating that unexpected monetary policy adjustments have a significant impact on the level of the exchange rate movements rather than on the volatility of the FX futures market.

Cyclical Variation in the Effect of Federal Funds Target Rate Surprises on Hospitality Index Returns

This paper examines the effect of US Federal Reserve monetary policy action announcements on hospitality index returns (HIRs) and provides evidence of cyclical variation in the impact of federal funds target rate surprises on US HIRs. To obtain a correct identification of monetary policy changes, the paper follows Kuttner in separating the surprise element from the expected element of the target rate changes. The surprise element is expected to have a strong influence on HIRs because the surprise component is not yet priced in the market. Test results show that funds target rate surprises can have a significant impact on airline, gambling, hotel and travel and leisure index returns, but actual funds target rate changes and the expected component have no strong impact on HIRs. Moreover, the significant influence of funds target rate surprises on HIRs depends on business conditions and is much greater in size and statistical significance in business contraction. In particular, the significant effects of federal funds target rate surprises on airline, hotel and restaurant index returns are found to exist only during periods of business cycle contraction.

Monetary policy transmission in vector autoregressions: A new approach using central bank communication

In this paper, we study the role played by central bank communication in monetary policy transmission. We employ the Swiss Economic Institute’s Monetary Policy Communicator to measure the future stance of the European Central Bank’s monetary policy. Our results indicate, first, that communication has an influence on inflation (expectations) similar to that of actual target rate changes. Communication also plays a noticeable role in the transmission of monetary policy to output. Consequently, future work on monetary policy transmission should incorporate both a short-term interest rate and a communication indicator. A second finding is that the monetary policy transmission mechanism changed during the financial crisis as the overall effect of monetary policy on (expected) inflation and output is weaker and of shorter duration during this period compared to the overall sample period.

Did Federal Funds Target Rate Changes Affect the Market Value of Insurance Companies?

In this paper, we study the sensitivity of insurance companies’ stock returns with respect to expected and unexpected changes in the Federal funds target rate over the period 1988-2007. We confirm Bernanke and Kuttner (2005) that, as stocks in general, insurance stock returns are only sensitive to the unexpected changes in the Federal funds target rate, but not to the expected ones. However, market-adjusted stock returns do only show a reaction for the non-life insurers. For life insurers, there does not seem to be an industry specific effect on their market value. This can be explained by the business models life and non-life insurers adopt.

Communication matters: US monetary policy and commodity price volatility

We analyze the influence of US monetary policy on commodity price volatility. Expected target rate changes and communications decrease volatility, whereas target rate surprises and unorthodox measures increase it. The “calming” effect of communication is reduced during the financial crisis.

The effects of Federal funds rate surprises on S&P 500 volatility and volatility risk premium

Abstract In this paper, we examine the effects of expected and surprise components in Federal funds target rate changes on realized and implied volatility. We find that surprise changes in the target rate significantly increase volatility. Consistent with the efficient market hypothesis, our analysis suggests that the expected component of a target rate change as well as the target rate change itself, do not significantly affect volatility. We also show that larger than expected decreases in the Federal funds target rate tend to lower the volatility risk premium.

Federal Reserve Communications and Emerging Equity Markets

Work on the impact of U.S. monetary policy on emerging financial markets mostly focuses on official target rate announcements; empirical evidence using data on informal communication channels, such as speeches, is scant. Employing a unique data set covering formal and informal communication channels in a generalized autoregressive conditional heteroskedasticity model framework, we provide comprehensive evidence on the effects of U.S. monetary policy on 17 emerging equity market returns over the period 1998–2009. We find, first, that both monetary policy actions and communications have a significant impact on market returns. Second, target rate change surprises are an important driver of emerging market returns. However, informal communications—particularly when taking into account their higher frequency—have a larger (cumulative) influence on returns than do target rate surprises. Third, during the recent financial crisis, central bank communication played an even more pronounced role. Finally, American emerging markets react more to communications than do non‐American markets.

Federal Reserve Communications and Emerging Equity Markets

Work on the impact of U.S. monetary policy on emerging financial markets mostly focuses on official federal funds rate announcements; empirical evidence using data on informal communication channels, such as speeches, is scant. Employing a unique data set covering formal and informal communication channels in a GARCH model framework, we provide comprehensive evidence on the effects of U.S. monetary policy on 17 emerging equity market returns over the period 1998–2009. We find, first, that both monetary policy actions and communications have a significant impact on market returns. Second, target rate change surprises are an important driver of emerging market returns. However, informal communications - particularly when taking into account their higher frequency - have a larger (cumulative) influence on returns than do target rate surprises. Third, during the financial crisis, central bank communication plays an even more pronounced role. Finally, American emerging markets react more to U.S. central bank communications than do non-American markets. We discuss the policy implications of the findings.

Monetary Policy Transmission in Vector Autoregressions: A New Approach Using Central Bank Communication

In this paper, we study the role played by central bank communication in monetary policy transmission. We employ the Swiss Economic Institute’s Monetary Policy Communicator to measure the future stance of the European Central Bank’s monetary policy. Our results indicate, first, that communication has an influence on inflation (expectations) similar to that of actual target rate changes. Communication also plays a noticeable role in the transmission of monetary policy to output. Consequently, future work on monetary policy transmission should incorporate both a short-term interest rate and a communication indicator. A second finding is that the monetary policy transmission mechanism changed during the financial crisis as the overall effect of monetary policy on (expected) inflation and output is weaker and of shorter duration during this period compared to the overall sample period.

Bank characteristics and stock reactions to federal funds rate target changes

This study investigates how bank characteristics affect bank stock reactions to changes in the federal funds rate target. Using a data set of all publicly listed banks of the United States from October 1988 through December 2007, we find that (1) the effect of changes in the federal funds rate target is more pronounced on large banks than on small banks; (2) banks that rely more on nondeposit funding sources are more responsive to such changes; (3) banks with higher capital ratios are less sensitive to unexpected target changes, but when the ratio increases to a certain level, the marginal effect diminishes. We observe that business activity mix does not matter to banks’ sensitivity to monetary shocks. This study is among the first to investigate how bank stock sensitivity to monetary shocks is conditional on various bank characteristics.

Bank Characteristics and Stock Reactions to Federal Funds Rate Target Changes

This study investigates how bank characteristics affect bank stock reactions to changes in the federal funds rate target. Using a dataset of all publicly listed banks of the United States from October 1988 through December 2007, both our regression analysis and categorical analysis provide supportive evidence that (1) the effect of changes in the federal funds rate target is more pronounced on large banks than on small banks; (2) banks that rely more on non-deposit funding sources are more responsive to such changes; (3) banks with higher capital-to-asset ratio are less sensitive to unexpected target changes, but when the capital ratio increases to a certain level, the marginal effect diminishes. We observe that business activity mix does not matter to banks’ sensitivity to monetary shocks. This study is among the first to investigate how bank stock sensitivity to monetary shocks is conditional on various bank characteristics. Our findings bear directly on the research of the causes and consequences of the 2008 financial crisis.

Communication Matters: U.S. Monetary Policy and Commodity Price Volatility

Using a GARCH model, we analyze the influence of U.S. monetary policy action and communication on the price volatility of commodities for the period 1998–2009. We find, first, that U.S. monetary policy events have an economically significant impact on price volatility. Second, expected target rate changes and communications decrease volatility, whereas target rate surprises and unorthodox monetary policy measures increase it. Third, we find a change in reaction to central bank communication during the recent financial crisis: the “calming” effect of communication found for the whole sample is partly offset during that period.