Fearing the Fed: How Wall Street Reads Main Street

Abstract

We document a countercyclical sensitivity of the stock market to major macroeconomic news announcements. Stock prices react more to (either good or bad) announcement surprises when the economy is below its potential trend with the expectation of easing policy. Based on comprehensive regression analyses and a no-arbitrage asset pricing model with state-dependent dynamics of cash flows (dividends), interest rates (monetary policy), and risk premium (market price of risk), we argue that this cyclical pattern is driven by the procyclical nature of monetary policy expectation and countercyclical nature of market price of risk.

Keywords: Macroeconomic news announcements, cyclical return variation, monetary policy expectations, business cycle, news decomposition, risk premium

JEL Classification: G12, E30, E40, E50