Brian Sack | Macro Paper Warehouse

Do Actions Speak Louder Than Words? The Response of Asset Prices to Monetary Policy Actions and Statements

This 2005 International Journal of Central Banking paper by Refet Gürkaynak, Brian Sack, and Eric Swanson tests whether asset-price responses to FOMC announcements can be adequately characterized by a single factor – the surprise change in the current federal-funds-rate target – and rejects that hypothesis using intraday (high-frequency) data around every FOMC announcement from January 1990 through December 2004. Using tick-by-tick federal funds futures, Eurodollar futures, on-the-run Treasury yields, and S&P 500 quotes measured in a tight 30-minute window (10 minutes before to 20 minutes after the announcement) and a wide one-hour window, the authors first show that narrowing the event window from a full day to 30 minutes sharply improves precision: the R-squared of the funds-rate-surprise regression on the S&P 500 triples from .12 (daily) to .36 (tight window), standard errors roughly halve, and the high-frequency design neutralizes the simultaneity and omitted-variable problems (notably contemporaneous employment reports) that contaminate daily- or monthly-frequency identification. They then fit a latent-factor model to the funds-rate-futures and Eurodollar-futures responses (138 FOMC announcements) and to Treasury-plus-stock responses (120 announcements), and use a Cragg-Donald (1997) matrix-rank test to reject both the zero-factor and one-factor hypotheses while failing to reject two factors. Rotating the two estimated principal components so the second has no effect on the current-month funds futures rate produces a “target” factor – surprise changes in the current funds-rate target, essentially the standard Kuttner (2001) measure – and a “path” factor, capturing movements in year-ahead policy expectations that are orthogonal to the current-rate surprise. The path factor is strongly associated with FOMC statements (regressing the absolute path factor on a statement-release dummy gives a coefficient of 0.070, R-squared = .18, and nine of the ten largest path-factor moves, including the largest on January 28, 2004, fall on statement dates) and it dominates the long end of the yield curve: in a joint two-factor regression, a one-percentage-point target surprise moves 2-/5-/10-year Treasury yields by 49/28/13 basis points and the S&P 500 by about -4.3%, while a one-percentage-point path innovation moves 5-/10-year yields by 37/28 basis points – a larger long-end effect – alongside a much smaller (roughly -1%) stock-market response; comparing one- versus two-factor R-squareds, the path factor accounts for roughly two-thirds of the explainable variation in two-year yields, three-fourths in five-year yields, and nine-tenths in ten-year yields, i.e., 75 to 90 percent of the explainable variation in long-term yields traces to statements rather than to funds-rate actions. An out-of-sample check using the first FOMC minutes released on the accelerated 2005 schedule (January 4, 2005) finds Treasury-yield movements broadly in line with the path-factor-implied predictions from the main sample, though the S&P 500 and long-forward-rate responses diverge somewhat from predicted magnitudes. The authors read the results as showing that FOMC statements are not an independent policy instrument but work by shaping financial-market expectations of future funds-rate actions, with a secondary possibility that the path factor also reflects revisions to expected output and inflation; the policy implication they draw is that the FOMC retains substantial ability to move long-term rates through a state-contingent path for the funds rate, and so is “largely unhindered” even when the current funds rate is at or near zero, consistent with Reifschneider-Williams (2000) and Eggertsson-Woodford (2003).

The Financial Market Effects of the Federal Reserve's Large-Scale Asset Purchases

This 2011 International Journal of Central Banking paper by Gagnon, Raskin, Remache, and Sack provides the founding empirical assessment of the Federal Reserve’s first large-scale asset purchase program (LSAP1, later known as QE1): between December 2008 and March 2010 the Fed bought more than $1.7 trillion of longer-term Treasury, agency debt, and agency mortgage-backed securities, roughly 22% of the $7.7 trillion stock of those securities outstanding (about $850 billion, or over 20% of the $3.7 trillion stock, measured in duration-equivalent “ten-year equivalents”). The authors argue the purchases worked mainly through a portfolio-balance channel — removing duration from the market forces the private sector to hold less of that duration risk, bidding up prices and compressing term premiums across asset classes, including on securities the Fed never bought — rather than through a signaling channel that would work by lowering expected future short-term rates; MBS purchases additionally reduced prepayment/negative-convexity risk, and an early market-functioning/liquidity channel narrowed unusually wide agency and MBS spreads. Two independent empirical strategies are used. An event study of cumulative one-day changes around an eight-announcement “baseline event set” (November 2008 through November 2009) finds the 10-year Treasury yield fell 91 basis points, the 10-year agency debt yield fell 156 bp, agency MBS yields fell 113 bp, the 10-year Kim-Wright term premium fell 71 bp, the 10-year swap rate fell 101 bp, and the Baa corporate index fell 67 bp, while the 2-year Treasury yield fell only 34 bp — a pattern the authors read as showing the effect worked mainly through the term premium rather than expected future policy rates, since the two announcements that also carried forward-guidance language moved the Kim-Wright one-year-ahead instantaneous rate by only about 4 bp each. A separate time-series regression of the 10-year Kim-Wright term premium (monthly, January 1985-June 2008) on cyclical, uncertainty, and net public debt-supply variables, estimated by OLS and dynamic OLS exploiting a cointegrating relationship, implies the full $1.725 trillion LSAP program (about 12% of 2009 GDP) lowered the 10-year term premium by roughly 38-82 basis points depending on specification — a range the authors emphasize “overlaps considerably” with the event-study estimates despite using entirely different data and methods. The net 10-year Treasury yield did not actually fall over the full program window (it rose over 100 bp on non-event days), which the authors attribute to a rising expected fiscal deficit and a strengthening outlook rather than to any reversal of the LSAP effect. International comparisons show the UK’s 2009-10 gilt purchases produced a “strikingly similar” roughly 100 bp decline in 5-25-year yields, while Japan’s smaller and shorter-duration 2001-06 purchases had little effect on longer-term yields.

The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models

This 2005 American Economic Review paper by Refet Gürkaynak, Brian Sack, and Eric Swanson asks whether long-term forward interest rates respond to daily macroeconomic and monetary-policy news, a question motivated by the fact that standard New Keynesian models – both the purely forward-looking Clarida-Gali-Gertler (2000) specification and the more persistent, partially backward-looking Rudebusch (2001) model – imply that the short-term interest rate returns to its steady state within roughly a decade after any shock, so far-ahead forward rates should show virtually no response to current news. Using daily U.S. Treasury forward rates (built from the Federal Reserve Board’s Svensson-method zero-coupon yield curve, off-the-run notes and bonds) over January 1990-December 2002, the authors regress the daily change in the forward rate at a given horizon on the surprise components of 13 macroeconomic data releases (the released value minus the median Money Market Services survey forecast, standardized by its historical standard deviation) and a federal-funds-futures-based measure of the monetary policy surprise, estimating the regression separately by OLS with Huber-White standard errors for horizons out to 15 years ahead. They find that far-ahead forward rates do respond significantly: for the forward rate ending five years ahead, 11 of the 13 macro surprises are significant at the 10-percent level (e.g., a one-standard-deviation surprise in non-farm payrolls moves the five-year-ahead forward rate by 3.48 basis points, GDP advance by 4.12 bp, the employment cost index by 4.42 bp), and 10 of 13 remain significant at the ten-year-ahead horizon, with the persistence of these effects out to 15 years described by the authors as “remarkable.” Monetary policy surprises behave differently across horizons: a surprise tightening raises near-term forward rates, consistent with the persistence of the federal funds rate, but forward rates roughly 9-15 years ahead move significantly in the opposite direction from the policy surprise – a pattern the paper contrasts with Cook and Hahn (1989) and Romer and Romer (2000), who study long-term yields (which mix in near-term rate expectations) rather than far-ahead forward rates, and attributes the discrepancy partly to their less precise policy-surprise measures. To explain this evidence that “the long-run expectations of economic agents are not strongly anchored,” the authors extend a standard asset-pricing/Fisher-equation framework by letting private agents’ estimate of the Federal Reserve’s unobserved long-run inflation target evolve over time, updated via a Kalman-filter-type rule in response to incoming data; they show that with small updating parameters (theta = 0.02 on trailing inflation, kappa = 0.1 on the monetary policy surprise) this single modification reproduces the full pattern of forward-rate responses observed in the data. They note corroborating survey evidence that the Survey of Professional Forecasters’ median ten-year CPI inflation forecast fell from about 4 percent in 1991Q4 to a little under 2.5 percent by the end of 2002, a roughly 1.5-percentage-point decline that “matches closely” the decline seen in the long-term forward-rate data. The authors are explicit that they cannot fully separate this inflation-target channel from a changing inflation/term risk premium, and that their approximation for the inflation-target process is valid only while inflation remains within the relatively low range observed over the sample; the 1990-2002 sample also predates the zero lower bound, unconventional monetary policy, and later tightening cycles.