Federal Open Market Committee Meeting Effect in Stocks

One market wisdom says – „Don’t fight the FED“, and academic research agrees with it. Academic studies show that the S&P 500 index average daily returns during Federal Open Market Committee meetings since 1980 (since FED started to be less secretive and more open about its plans and actions) are outstanding – more than five times greater than returns during other average days on the market. It means that more than 16% of average yearly returns for the equity index is realized during very few days.

Therefore it handsomely pays to be long during these few days. A simple market timing strategy that exploits this anomaly could be created. As it is only a few days in a year, this strategy could be easily leveraged to obtain higher returns.

Fundamental reason

FOMC meetings are mostly positive for the stock market. The FED’s purpose is to address banking panics, maintain the stability of the financial system, contain systemic risk in financial markets, and strengthen economic growth. Therefore it is highly unlikely that FOMC meetings’ conclusions would be highly negative for stocks. This is the main cause of a positive drift.

Get Premium Trading & Strategy Ideas

  • Unlocked Screener & Advanced Charts
  • 370+ uncommon trading strategy ideas
  • New strategies on a bi-weekly basis
  • 800+ links to academic research papers
  • 100+ out-of-sample backtests
Markets Traded

Financial instruments
CFDs, ETFs, funds, futures

Confidence in anomaly's validity

Backtest period from source paper

Notes to Confidence in Anomaly's Validity

Indicative Performance

Period of Rebalancing

Notes to Indicative Performance

per annum, return calculated for investor which is long stocks (average daily return 0.2734% – table 1) during FOMC meeting and invested in cash for remaining days (4% return on cash is expected)

Notes to Period of Rebalancing

Estimated Volatility

Number of Traded Instruments

Notes to Estimated Volatility

not stated

Notes to Number of Traded Instruments

Maximum Drawdown

Complexity Evaluation
Simple strategy

Notes to Maximum drawdown

not stated

Notes to Complexity Evaluation

Sharpe Ratio

Simple trading strategy

The investor is invested in stocks during FOMC meetings (going long S&P 500 ETF, fund, future, or CFD on a close one day before the meeting and closing position on close after the meeting). Otherwise, he is invested in cash during the remaining days. The strategy has very low exposure to the stock market (8 days during the average year); therefore, it can be very easily leveraged to gain very significant returns.

Hedge for stocks during bear markets

No - The strategy is timing equity market but invests long-only into equity market factor (even that only for a short period of time); therefore is not suitable as a hedge/diversification during market/economic crises.

Source paper
Tori: Federal Open Market Comitee meetings and stock market performance
- Abstract

This paper examines an interesting calendar effect – a relationship between contemporaneous stocks market returns and Federal Open Market Comitee (FOMC) meeting dates. Examining S&P 500 stock market returns between 1960 and 2000, the study finds that there is a positive and significant calendar effect associated with FOMC meeting dates. The data reveal that while FOMC meeting dates only accounted for 4.42% of the trading days, FOMC meeting date returns accounted for over 13% of the cumulative returns over the time period. Using a dummy variable for FOMC meeting dates, regression results find that the FOMC meeting dates have a significantly positive effect on overall market returns.

Strategy's implementation in QuantConnect's framework (chart+statistics+code)
Other papers
Lucca, Moench: The Pre-FOMC Announcement Drift
- Abstract

Since the Federal Open Market Committee (FOMC) began announcing its policy decisions in 1994, U.S. stock returns have on average been more than thirty times larger on announcement days than on other days. Surprisingly, these abnormal returns are accrued before the policy announcement. The excess returns earned during the twenty-four hours prior to scheduled FOMC announcements account for more than 80 percent of the equity premium over the past seventeen years. Similar results are found for major global equity indexes, but not for other asset classes or other economic news announcements. We explore a few risk-based explanations of these findings, none of which can account for the return anomaly.

Nilsson: The Pre-FOMC Drift Explored
- Abstract

The pre-FOMC drift was first published in 2011 and is a strong driver of equity market performance over the last 30 years. The effect is able to explain approximately half of all the equity market returns over the measured period. We verify the results of prior studies. Furthermore, the report dives into conditional factors; equity market trend and monetary policy action to see if there is any difference in terms of macro variables. We find that FOMC is rather stable throughout time, macro conditions and has not been dependent on a particular Fed Chair. It seems as if the markets are expecting that the FOCM will infuse optimism into equity markets as the majority of the gains occurs before the actual announcement. The effect can be due to behavioral issues and herding among market participants but can also be due to information leakage. The effect remains unexplained.

Cocoma: Explaining the Pre-Announcement Drift
- Abstract

I propose a theoretical explanation for the puzzling pre-announcement positive drift that has been empirically documented before scheduled Federal Open Market Committee (FOMC) meetings. I construct a general equilibrium model of disagreement (difference-of-opinion) where two groups of agents react differently to the information released at the announcement and to signals available between two announcement releases. In contrast to traditional asset pricing explanations, this model matches key empirical facts such as (1) the upward drift in prices just before the announcement, (2) lower (higher) risk, price volatility, before (after) the announcement occurs, and (3) high trading volume after the announcement, while trading volume is low before the announcement occurs.

Hull, Bakosova, Kment: Seasonal Effects and Other Anomalies
- Abstract

We revisit a series of popular anomalies: seasonal, announcement and momentum. We comment on statistical significance and persistence of these effects and propose useful investment strategies to incorporate this information. We investigate the creation of a seasonal anomaly and trend model composed of the Sell in May (SIM), Turn of the Month (TOM), Federal Open Market Committee pre-announcement drift (FOMC) and State Dependent Momentum (SDM). Using the total return S&P 500 dataset starting in 1975, we estimate the parameters of each model on a yearly basis based on an expanding window, and then proceed to form, in a walk forward manner, an optimized combination of the four models using a return to risk optimization procedure. We find that an optimized strategy of the aforementioned four market anomalies produced 9.56% annualized returns with 6.28% volatility and a Sharpe ratio of 0.77. This strategy exceeds that Sharpe ratio of Buy-and-Hold in the same period by almost 100%. Furthermore, the strategy also adds value to the previously published market-timing models of Hull and Qiao (2017) and Hull, Qiao, and Bakosova (2017). A simple strategy which combines all three models more than doubles the Sharpe ratio of Buy-and-Hold between 2003-2017. The combined strategy produces a Sharpe ratio of 1.26, with annualized returns of 18.03% and 13.26% volatility. We publish conclusions from our seasonal trend and anomaly model in our Daily Report.

Hu, Pan, Wang, Zhu: Premium for Heightened Uncertainty: Solving the FOMC Puzzle
- Abstract

Lucca and Moench (2015) document that prior to the announcement from FOMC meetings, the stock market yields substantial returns without major increase in conventional measures of risk. This presents a “puzzle” to the simple risk-return connection in most (static) asset pricing models. We hypothesis that the arrival of macroeconomic news, with FOMC announcements at the top of the list, brings heightened uncertainty to the market, as investors cautiously await and assess the outcome. While this heightened uncertainty may not be accurately captured by conventional risk measures, its dissolution occurs during a short time window, mostly prior to the announcement, bringing a significant price appreciation. This hypothesis leads to two testable implications: First, we should see similar return patterns for other pre-scheduled macroeconomic announcements. Second, to the extent that we can find other proxies for heightened uncertainty, we should also observe abnormal returns accompanying its dissolution. Indeed, we find large pre-announcement returns prior to the releases of Nonfarm Payroll, GDP and ISM index. Using CBOE VIX index as a primitive gauge for market uncertainty, we find disproportionally large returns on days following large spike-ups in VIX. Akin to the FOMC result, we find that while such heightened-uncertainty days occur on average only eight times per year, they account for more than 30% of the average annual return on the S&P 500 index. Conversely, we find a gradual but significant build-up in VIX prior to FOMC days, providing direct evidence of heightened uncertainty.

Martello, Ribeiro: Pre-FOMC Announcement Relief
- Abstract

We show that the pre-FOMC announcement drift in equity returns occurs mostly in periods of high market uncertainty or risk premium. Specifically, this abnormal return is explained by a significant reduction in the risk premium (implied volatility and variance risk premium) prior to the announcement, but only when the risk premium is high, e.g., when it is above its median. Likewise, the magnitude of the FOMC Cycle and other related patterns varies with uncertainty and risk premium. Market uncertainty measures are persistent and are not related to policy uncertainty or expectations. Markets become only marginally stressed in the days prior to the announcement and changes in uncertainty appear to be of lower frequency. We also explain why recent studies suggest that the pre-FOMC drift might have disappeared in the past decade, as this moderation is due to time variation that was also present in older data. Additionally, CAPM only works on FOMC dates when the risk premium is high, e.g., implied vol above its prior median level. The results are robust to different samples and measures of risk premium and uncertainty.

Get Quantpedia Premium

  • Unlocked Screener & Advanced Charts
  • 380+ uncommon trading strategy ideas
  • New strategies on a bi-weekly basis
  • 800+ links to academic research papers
  • 120+ out-of-sample backtests

Subscribe for Newsletter

Be first to know, when we publish new content

The Encyclopedia of Quantitative Trading Strategies

Log in