Remember that 2011 NY Fed study which found that since 1994, there was a distinct and observable tendency for the S&P 500 to rise in the period just before FOMC meetings. In fact, as authors David Lucca and Emanuel Moench found, a stunning 80% of all equity returns for U.S. stocks (in the 1994-2011 period) were generated over the twenty-four hours preceding scheduled Federal Open Market Committee announcements, a phenomenon called “the pre-FOMC drift.”
While the authors provided several possible explanations why this trade worked as well as it did, there was never a definitive agreement. In any case, the news of “drift” became so prevalent, and the trade so popular that eventually it became a self-fulfilling prophecy as traders bought into the “drift” ahead of the FOMC, expecting other traders to buy the trade, and so on, in the process becoming one of the “safest” trades in the stock market.
Yet cracks emerged earlier this year, when some analysts started questioning whether this strategy was indeed as fail-safe as the Fed, and subsequent trader lore, made it out to be, with Kevin Muir going so far as to compartmentalize the trade’s returns, finding that after a steady rise from 2009 to 2015, over the past three years, the strategy has flatlined, prompting the following conclusion:
the Federal Reserve made its first hike in almost a decade on December 15th, 2015 and this was also the point where the FOMC Drift stopped working
Perhaps hearing these trader complaints about their “strategy”, earlier today the NY Fed authors of the original study, Lucca and Moench, reran the data to update their original analysis with more recent data.
What they found was surprising: while there is still evidence of continued large excess returns during FOMC meetings in the period 2011-2018, it only occurs on those days featuring a press conference by the Chair of the FOMC. On days without a presser, not only has the upward drift disappeared, but market returns have actually been notably negative.
As the NY Fed authors note, the chart below updates their original analysis through the period starting in April 2011 and ending in June 2018. It is worth noting that since April 2011, the Fed Chair has been giving a press conference at every other FOMC meeting. At these meetings the FOMC also releases the summary of its members’ economic projections (SEP), so that three forms of communication take place: the FOMC statement, the SEP, and the press conference with the Chair.
In 2011 and 2012, FOMC statements (including the SEP) that were scheduled with a press conference were released at 12:30 p.m., and the press conference started at 2:15 p.m. FOMC statements without a press conference (and hence without SEP) were released at 2:15 p.m. as in the pre-2011 sample. Starting in 2013, FOMC statements are always released at 2:00 p.m., while press conferences start at 2:30 p.m. (and SEP material is released at the start of the conference). The chart below shows four vertical lines that mark each of these times.
The results of the study are summarized in the next chart, which shows the distinct outperformance on presser days, vs the clear underperformance on days without a press conference (or economic projections) when the market’s return is effectively as negative as it is positive during presser days.
This may explain why using a blended analysis of the “Pre-FOMC drift” trade shows that it no longer works: it does work, only not on non-presser days. Here is the authors’ take:
On days without a press conference, there is no longer any evidence of excess returns ahead of the release of the FOMC statement. While we see negative returns following the release of the statement, this effect is not statistically significant, as the gray shaded area encompasses the zero line. Instead we see large returns ahead of announcements for meetings with press conferences. Interestingly, these returns accrue a bit earlier than in the pre-2011 sample, and more specifically, in the morning of the day before the announcement.
In addition, there is some further appreciation at, and after, the announcement(s). On net, the pre-FOMC announcement drift on press conference days is about 40 basis points when computed from the open of the day before to about lunchtime of the day of the announcement day—in line with the pre-FOMC drift in the original sample. One can also see an additional 30 basis points return by the end of the press conference, which could reflect news released either in the statement, press conference, or SEP, or a risk premium as predicted by financial theory (see, for example, Ai and Bansal or Wachter and Zhu). What remains puzzling in the post-2011 period is the pre-FOMC announcement drift.
What may account for this bifurcation in returns on presser vs non-presser days? One possible explanation is that since the economic projections – which traditionally tend to be overly optimistic (as they are made by the Fed) – are only released at meetings with press conferences and since policy rate changes have only taken place at these meetings since 2011, the authors note that some investors have “reportedly discounted the amount of information that could be released at meetings without press conference.” And,consistent with this attention reallocation hypothesis, this may have reduced the amount of re-pricing ahead of the meetings absent press conferences.
Still, as the authors note, an “attention reallocation hypothesis” still begs the question as to why some sophisticated investors would not attempt to profit from the positive returns. Well, as we said up top, it appears that they do, and according to the NY Fed study, “the timing of the post-2011 returns suggests that such activities may have occurred.”
Pre-FOMC returns were positive in the post-2011 sample on press conference days from the open of the day before the FOMC, while cumulative returns were positive starting only in the afternoon of the day before the announcement in the pre-2011 sample. This suggests that some investors could be attempting to profit from the pre-FOMC returns, pushing prices up earlier than before.
And the punchline from the authors, who muse that if this arbing by sophisticated investors was the reason for the shift in the timing of the returns, “such a process would imply that the pre-FOMC returns should eventually disappear.“
In theory yes, but in practice it takes a lot of time to wean traders away from a trade, especially one as heavily incorporated into trader psyche as this one.
The silver lining here is that while the trade may no longer work – at least half the time, on those FOMCs when there is no presser – it will soon be retested in its full, 100% glory. The reason: as the Fed announced in June starting January 2019, all FOMC meetings will include a press conference.
As the authors conclude: “it remains to be seen if the pre-FOMC announcement drift is to again become a more regular phenomenon or the extent to which any future arbitrage activity could make the pre-FOMC drift disappear.“
Something tells us that in a world in which increasingly fewer “sure” trades work, it is only a matter of time before the market’s “safest trade” is back in vogue, even if there is really no fundamental reason why it should work… besides of course belief in the presence of even greater fools.
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