Exchange Rates and FOMC Days

FOMC meeting days provide a natural laboratory for exploring the effects of policy uncertainty and learning on exchange rate determination. Intradaily mark/dollar exchange rates are employed for 10 FOMC meetings. The meetings examined are the first 10 following the February 1994 change in policy where the meeting outcome is announced after meetings end. The following hypotheses motivated by the market microstructure literature are examined: 1) strategic behavior by informed traders should result in position-taking prior to meeting end and the revelation of policy and 2) bid-ask spreads should widen due to adverse selection potential as the probability of quoting to an informed trader increases. A markov-switching model is used to estimate the time of informed position-taking. The data suggest that on most days, there is a switch to the informed-trading state during the time of the meeting, well before the end of the meeting. An extensive search of public news indicates that the informed trading cannot be explained as the response to public information. An ordered probit model of the bid-ask spread is estimated as a function of the probability of being in the informed trading state. The estimation results indicate that the greater the probability of being in the informed trading state, the wider spreads. This is consistent with dealers protecting against adverse selection in quoting. The evidence indicates that meeting outcomes are generally anticipated during the meeting. In this sense, the realization of the meeting outcome is often not news.