March 15, 2013

Fed Events & Rate Volatility: Goldman Sachs

March 15, 2013

Fed Events & Rate Volatility: Goldman Sachs

Below is a great report Goldman Sachs published this week on the Fed’s impact on rate markets.


– Fed events−including statements, minutes, and speeches−often move the market. But how important have Fed events been in driving markets over time, and what events have caused the largest market moves? To answer these questions, we construct a database of 3,479 Fed events since 2001 and cross-list it with intraday moves in the 10-year Treasury yield.

– Market volatility is highest following the release of FOMC statements and meeting minutes. Speeches generate less volatility, but members of the Fed leadership (the Chairman, Vice Chair, and President of the New York Fed) move the market most.

– A cumulative index of Fed event “surprises” generally moves with the broader level of Treasury yields over time. During late 2008/early 2009, and again in mid 2011, Fed events appear to have been particularly important drivers of yields. In contrast, a relatively modest fraction of the roughly 40 basis point rise in the 10-year Treasury yield since December 2012 has occurred around Fed events.

Fed events−including statements, minutes, and speeches−often move the market, sometimes in an out-sized way. For example, the largest daily move in term rates in recent memory occurred following the March 2009 FOMC meeting, when the 10-year yield fell by roughly half a percentage point. However more often than not, Fed events have quite small impacts on the market, indistinct from normal intraday volatility. Today’s Daily develops an index of rate moves around Fed events that allow us to track the contribution of Fed events to changes in the 10-year Treasury yield over time, and asks “what does the market listen to most?”

Constructing the Fed Events Index
We built a database of 3,479 Fed events going back to 2001, including FOMC statement releases, meeting minutes, the Chairman’s semi-annual monetary policy testimony before Congress, and speeches from members of the Board of Governors and regional Fed presidents. Each event has a timestamp which is cross-listed against a database of intraday data on the 10-year on-the-run Treasury note yield (10 minute increments). As a starting point, we calculate yield changes in a one-hour interval around events. A number of “exclusions” are then applied to clean the data. An observation is thrown out if (1) a speech is clearly not about monetary policy or the economic outlook based on its title, (2) a speech occurs on a weekend, (3) a speech occurs in close proximity to the release of the nonfarm payrolls report, (4) a speech occurs too close to another speech to separate the surprise windows, (5) a speech occurs well outside of normal US trading hours, or (6) intra-day yield data is missing or anomalous around the event.

What Does the Market Listen to Most?
Exhibit 1 shows several measures of yield volatility derived from our database by category of Fed event, highlighting the past three years in the first column and the full 2001 – 2013 period in the second column. As shown by the average absolute yield changes around events, market volatility is highest following the release of FOMC statements and meeting minutes. Speeches generate less volatility, but Fed leadership (the Chairman, Vice Chair, and President of the New York Fed) move the market most, in line with intuition.


Exhibit 2 illustrates the relative importance of different types of Fed events in driving directional market moves over time, as measured by the sum of yield changes by year. Categories of events usually, but do not always, move in the same direction within the same year. Most strikingly, during 2009 Fed events were “firing on all cylinders” in contributing to lower term yields. FOMC statements and the Chairman’s speeches have been important drivers. Regional Fed president’s speeches, which are far more numerous than other events in the database, have also made significant contributions to the index. However, if a threshold for the absolute size of any individual surprise is used as a criterion for inclusion in the index (i.e. moves below a reasonable absolute threshold are assumed to be random noise), the regional Presidents’ contribution declines.


Index Responded to QE1 Announcements, Forward Guidance

Cumulative indices since 2001 are plotted in Exhibit 3, overlaid on the 10-year Treasury yield. There are two periods over the past several years when Fed event surprises appeared to drive Treasury yields most significantly. First, after the November 2008 and March 2009 QE announcements, and second, during summer 2011 when forward guidance was first introduced and Operation Twist was being priced into the market. While these surprises were largely “announcement based,” to the extent that markets have come to understand that unconventional policies such as QE and forward guidance are now a part of the Fed’s toolkit, they should price them in more gradually in response to incoming data on the outlook, rather than at the time of announcement. This explains why, for instance, there was relatively little market reaction around the extension of QE3 to Treasury securities in December 2012. Apart from policy announcements, Fed leadership speeches have also contributed significantly to changes in Treasury yields over the past 10 years. During the run-up to and coincident with the 2004 tightening cycle, speeches contributed to a gradual rise in the 10-year yield on net. Also, as energy prices rose during 2007 and 2008, and before the collapse in activity in Q4 2008, yields tended to rise around leadership speeches.


Recently Fed Events Have Been Less Important

Looking more closely at the period since early December 2012, over which the 10-year yield has risen more than 40 basis points, Exhibit 4 shows that a relatively modest fraction of the move is explained by changes in yields immediately around Fed events. Changes in expectations for Fed policy may nonetheless have been an important driver of yields over this period, but if so, those expectations must have adjusted more diffusely than immediately around Fed events. For example, expectations may have gradually shifted as data surprises improved and fiscal policy tail risks were partially priced out.