Beyond interest rates: monetary policy’s impact on asset prices
In this paper Christoph E. Boehm and T. Niklas Kroner argue that “U.S. monetary policy affects asset prices through channels that are not captured by interest rates” an assertion that is motivated by two facts: (i) yield-based monetary policy shocks have little explanatory power for stocks and currencies around FOMC announcements and (ii) stocks and currencies display elevated variances around these announcements. The authors develop a framework to estimate a monetary policy shock that is orthogonal to changes in interest rates (yield curve) around Federal Open Market Committee (FOMC) announcements. They use a heteroskedasticity-based identification procedure and Kalman filtering to estimate this “non-yield shock” from stock prices and exchange rates. The shock is identified by comparing the volatility of asset prices on FOMC announcement days versus non-announcement days, after controlling for yield changes. Finally, the authors estimate the shock using data on U.S. stock prices and various dollar exchange rates over 6-hour windows around FOMC announcements.
Key findings:
- The non-yield shock explains a large portion of stock price and exchange rate movements around FOMC announcements that is not captured by conventional yield-based monetary policy shocks.
- A positive non-yield shock raises U.S. and foreign stock prices and depreciates the dollar against major currencies.
- The effects of the non-yield shock on international financial markets are large and significant, often exceeding the effects of conventional monetary policy shocks.
- The non-yield shock is largely uncorrelated with existing monetary policy shock measures from the literature.
- Evidence suggests the non-yield shock operates primarily through a risk premium channel, affecting measures like the VIX and other risk-related indicators.
- The shock can be statistically linked to Fed communications, with more communication and discussion of risk-related topics associated with larger shock magnitudes.
- The existence of this shock has implications for the identification of structural monetary policy shocks, suggesting yield curve changes alone may not capture all dimensions of monetary policy.
Monetary Policy without Moving Interest Rates: The Fed Non-Yield Shock
Authors: Christoph E. Boehm, T. Niklas Kroner
From: UT Austin, Federal Reserve Board
The Fed’s internal deliberations and financial risk premia
Anna Cieslak and Michael McMahon investigates how the Federal Reserve’s (Fed) monetary policy influences financial risk premia, focusing on the implications of the Federal Open Market Committee’s (FOMC) forward-looking policy stance. The authors emphasize that understanding the Fed’s internal deliberations and communication is crucial for predicting market reactions.
Methodology
Cieslak and McMahon utilize a unique approach by analyzing transcripts from FOMC meetings to extract a measure of the Fed’s internal policy stance. This measure captures policymakers’ discussions regarding potential future policy changes, independent of current announcements or macroeconomic forecasts. The methodology can be summarized as follows:
Data Source: The study employs verbatim transcripts from FOMC meetings, which have been publicly available since 1994, covering meetings from August 1987 to December 2015.
Policy Stance Measurement: The authors develop a textual analysis framework to quantify the hawkishness or dovishness of the Fed’s internal discussions. This involves purging the language of its correlation with current policy choices and economic outlooks to isolate forward-looking intentions.
Key findings:
- Impact of Policy Stance on Risk Premia: A more hawkish stance from FOMC meetings predicts lower risk premia in financial markets during subsequent intermeeting periods. Specifically, a one-standard-deviation increase in hawkishness corresponds to a reduction in risk premium that accounts for approximately 17% of intermeeting ten-year yield volatility and 15% of stock return volatility.
- Gradual Effect: The influence of the Fed’s internal discussions on market risk perceptions unfolds gradually over time rather than causing immediate reactions at the time of announcements.
- Role of Communication: The authors highlight that while FOMC statements do not significantly impact market reactions, speeches by policymakers serve as a critical conduit for transmitting information about future policy stances, thereby affecting risk premia.
- Policy Mistakes and Market Perception: The paper also discusses how perceived policy mistakes can lead to increased risk premia, emphasizing that credible communication about potential future tightening can help stabilize financial markets.
Tough Talk: The Fed and the Risk Premium
Authors: Anna Cieslak, Michael McMahon
From: Duke University, University of Oxford
