What Happens When Equity Investors Disagree with the FOMC?
Posted: 8 Mar 2020
Date Written: February 6, 2020
This research explores an alternative explanation for the equity premium associated with Federal Open Market Committee (FOMC) announcement days that accounts for a sizable fraction of annual equity returns. My evidence shows that investor expectations formulated prior to FOMC announcements have a significant impact on equity prices, particularly when these expectations are not aligned with the FOMC decision. Furthermore, I document an even larger impact around FOMC announcements where the level of interest rates remained unchanged. When monetary policy is neutral, the observed investors’ disagreement towards the FOMC decisions represents a further layer of uncertainty in the dynamics of equity markets. My results reconcile past findings on the monetary policy surprise literature and more recent empirical findings on the effect of FOMC announcements, which are difficult to explain with standard asset pricing theories. Moreover, as I find little effects on equity returns when the FOMC decision is anticipated by the market, a practical implication of my study is that monetary policy authorities should take into account market expectations when formulating disclosure policy in order to improve alignment with financial market expectations and smooth out their economic consequences.
Keywords: Financial Markets and the Macroeconomy; Monetary Policy; Market Microstructure
JEL Classification: E44; E52; G12; G14;
Suggested Citation: Suggested Citation