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).

Eric T. Swanson | Macro Paper Warehouse

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