Asset Volatility and the FOMC Minutes

When the Federal Reserve Open Market Committee (FOMC) releases the minutes of its closed door meetings to the "sweaty masses", the world's investing community sits on the edge of its collective seat.  In this posting, I will summarize a study by Dr. Carlo Rosa at the New York Federal Reserve Bank that looks at the size of the impact of the release of the FOMC minutes on asset prices.

In recent years, the Federal Reserve has adopted a new policy of transparency and communication, allowing the unwashed access to the inner workings, mind set and deliberations of that august group of central bankers.  By doing this, the Federal Reserve hopes to eliminate some of the negative effects of policy surprises.  In his analysis, Dr. Rosa looks at the effect of the release of FOMC minutes on United States asset prices including two- and ten-year Treasuries, U.S. dollar exchange rates and stock prices using five minute intra-day data rather than closing data.  

Here is are two graphs (with time along the X-axis and standard deviation along the Y-axis) showing the standard deviation of five minute returns (i.e. volatility) of two- and ten-year Treasuries on the day that FOMC minutes are released (in blue) and the standard deviation of the five-minute returns on the same weekdays of the weeks before and after the FOMC minutes release (in dashed black), noting that the vertical black line marks the release time of the FOMC minutes (i.e. 2:00 pm EST): 

The graphs show a strong impact of the release of the FOMC minutes on Treasury prices that remains in place for up to one hour after the announcement with the impact on the two-year Treasury being higher than on the ten-year Treasury, with volatility sitting at about 0.016 or 1.6 basis points.   You'll observe that on non-FOMC minutes days, there is no change in Treasury prices whatsoever and that the normal volatility sits around 0.004 or 0.4 basis points.

Here is the impact on the United States dollar as measured using the euro and Japanese yen:

The impact of the FOMC minutes on the United States dollar is substantial, but the dollar is less volatile than Treasuries.

Here is the impact on the S&P 500:

The impact of the release of FOMC minutes on equities is far lower than on Treasuries or the United States dollar.

The author also notes that trading activity on the stock market is particularly low on the FOMC release day prior to the release of the data and rises and remains somewhat elevated after the announcement as shown on this graph:

This suggests that traders remain on the sidelines until the uncertainty surrounding the contents of the FOMC minutes is resolved.

Here is the impact on the United States dollar as measured using the euro and Japanese yen:

The impact on the United States dollar is substantial, but the dollar is less volatile than Treasuries.

To summarize, the author's findings indicate that the release of the FOMC minutes has a significant impact on both the volatility and volume of trading of stocks, Treasuries and currencies, something that most of us at least suspected.  Even after the initial effect, the market will seek its new equilibrium (either higher or lower depending on the perception of investors), taking into account the additional information generated by the FOMC announcements.  I found it particularly interesting how significant the impact of the FOMC minutes was on the volatility of Treasuries given that the Fed is doing everything in its power to suppress interest rates.