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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 1990-2006 (36 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 1990-2006, with one standard deviation error bars. The mean daily return for all 4,286 trading days in the sample is 0.04%. 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 unreliable for trading. In fact, the S&P 500 index declines on 17 of the 36 announcement dates. On the second trading day after announcements, 25 of 36 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 1990-2006, 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 short-term event trades.
It may be that failure to announce an anticipated decrease (increase) in the FFR has a reliable negative (positive) effect on stocks, but we do not have the means to test this hypothesis.
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 3/15/07 for analysis of longer-term effects of a change in the FFR.
