Blog - Investing Notes

November 5, 2008 - Update: U.S. Stock Returns Around Dates of FFR Changes

How do stocks behave in the few days around announcements of a change in the Federal Funds Rate (FFR)? Does evidence support the conventional expectation that a cut (boost) precipitates an immediate positive (negative) reaction by equities? To investigate, we analyze the historical behavior of the S&P 500 index from five trading days before through five trading days after the announcement dates for a change in the FFR during 1/90-10/08 (45 decreases and 31 increases). Using daily closing levels of the index, we find that...

The following chart shows the average daily S&P 500 index returns from five trading days before through five trading days after announcements of a decrease in the FFR during 1/90-10/08, with one standard deviation error bars. The mean daily return for all 4,749 trading days in the sample is 0.03%. Results on average suggest a modestly positive immediate response, a one-day reversal and then resumption of positive response. However, as usual for daily data and especially considering the small sample size, noise generally dominates signal such that this visual impression is risky for trading. In fact, the S&P 500 index declines on 23 of the 45 announcement dates. On the second trading day after announcements, 27 of 45 returns are negative.

It does appear that stock prices are more volatile than usual on announcement dates.

Is the response to announcements of an increase in the FFR more reliable?

The next chart shows the average daily S&P 500 index returns from five trading days before through five trading days after announcements of an increase in the FFR during 1/90-10/08, with one standard deviation error bars. Results on average suggest a positive anticipatory effect followed by post-announcement weakness. Noise again generally dominates signal such that this visual impression is of little use for trading. The S&P 500 index declines on 14 of the 31 announcement dates. Two days before announcements, 10 of 31 returns are negative. On the third trading day after announcements, 20 of 31 returns are negative.

It does appear that stock prices are somewhat less volatile around announcements of increases than around announcements of decreases.

In summary, evidence indicates that the days around announcements of a change in the Federal Funds Rate offer little in the way of reliable event trades.

It may be that that stocks respond systmatically to changes (or lack of changes) in FFR only to the degree that these changes surprise investors, but we cannot confidently measure the degree of surprise.

See Blog Synthesis: The Economy and the Stock Market for other research on relationships between macroeconomic indicators and stock market behavior. See especially our blog entry of 11/29/07 on intraday trading of FFR decisions.