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Fearing the Fed: How Wall Street Reads Main Street

Author

Listed:
  • Tzuo Hann Law

    (Boston College)

  • Dongho Song

    (Boston College)

  • Amir Yaron

    (University of Pennsylvania)

Abstract

Using intraday stock returns around macroeconomic news announcements (MNAs), we find strong evidence of persistent, cyclical variation in the stock market's response to MNA surprises. The response is particularly strong coming out of recessions and is gradually attenuated as the economy expands. We show that this cyclical pattern can be explained by a regime-switching model. In the model, we find that the direction and shape of the market's response reflect the evolution of beliefs about the state of the economy and monetary policy. The risk of an interest rate hike can entirely mitigate (and even reverse) the effect of positive MNA surprises on returns. This mechanism is consistent with the data -- positive MNA surprises coincide with negative stock market returns when there is substantial uncertainty over monetary policy.

Suggested Citation

  • Tzuo Hann Law & Dongho Song & Amir Yaron, 2017. "Fearing the Fed: How Wall Street Reads Main Street," 2017 Meeting Papers 1632, Society for Economic Dynamics.
    • Handle: RePEc:red:sed017:1632
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    References listed on IDEAS

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    Cited by:

    1. Malamud, Semyon & Schrimpf, Paul, 2018. "An Intermediation-Based Model of Exchange Rates," CEPR Discussion Papers 13182, C.E.P.R. Discussion Papers.
    2. Semyon Malamud & Andreas Schrimpf, 2016. "Intermediation Markups and Monetary Policy Passthrough," Swiss Finance Institute Research Paper Series 16-75, Swiss Finance Institute.
    3. Anthony M. Diercks & William Waller, 2017. "Taxes and the Fed : Theory and Evidence from Equities," Finance and Economics Discussion Series 2017-104, Board of Governors of the Federal Reserve System (U.S.).
    4. Kam F. Chan & Philip Gray, 2018. "Volatility jumps and macroeconomic news announcements," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 38(8), pages 881-897, August.
    5. Pascal Paul, 2020. "The Time-Varying Effect of Monetary Policy on Asset Prices," The Review of Economics and Statistics, MIT Press, vol. 102(4), pages 690-704, October.

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