Central bank communication and financial markets

The FOMC sentiment index

In this paper, Gardner et al. argue that equity markets react to the state of the economy as described by the Federal Open Market Committee (FOMC) statement, and not to the state of the economy as measured by a recession indicator variable or real-time economic indicators, as the previous literature suggests. They construct an FOMC sentiment index using textual analysis techniques. In particular, their algorithm matches topic words related to labor market, output, inflation, financial conditions, and future monetary policy actions to modifiers such as “increasing” or “decreasing.” They compute their FOMC index for the pre-pandemic period from 2000 to 2019 and find that news has a bigger (smaller) effect on equity prices during bad (good) times. In addition, the FOMC effect seem to dominate the uncertainty effect during the pre-pandemic period. This effect though reverses during the 2019-2020 period.

Words Speak as Loudly as Actions: Central Bank Communication and the Response of Equity Prices to Macroeconomic Announcements
Authors: Ben Gardner, Chiara Scotti, Clara Vega
From: Federal Reserve Board, Yale University

The Twitter index

In this paper Masciandro et al. look at the discussions on Twitter triggered by announcements by the ECB, the Fed and the Bank of England. They use machine learning techniques to construct a measure of similarity between non-experts’ market sentiment based on their Twitter activity and the information provided in the central bank press releases. They find:

[T]hat large dissimilarities in tweets pre and post announcements are associated with higher market volatility, suggesting that our Twitter-based measure of market sentiment is a good proxy for monetary policy surprises.

Monetary policy, Twitter and financial markets: evidence from social media traffic
Authors: Donato Masciandaro, Davide Romelli, Gaia Rubera
From: Bocconi University, Trinity College

What is the Fed communicating now?

[Why, then, is the Fed so reluctant to act?] Another possible explanation is politics. The Biden administration has yet to signal whether it plans to appoint Chair Powell to a second term when his current one runs out in February. If Powell wants reappointment, it might behoove him to curry favor with the administration and its left-wing critics by keeping monetary policy loose. I certainly hope this isn’t the case: Whether conscious or not, it would represent the same kind of monetary-policy politicization that many economists believe gave rise to the runaway inflation of the 1970s. That’s an experience nobody should want to repeat.

Is the Fed Playing Politics With Interest Rates?
By: Narayana Kocherlakota – University of Rochester