An astonishing pattern always emerges before interest rate decisions by the US Federal Reserve. Stocks rise, volatility falls and after the decision the momentum often changes.
• Studies show: A large portion of stock returns occur before Fed decisions
• Stocks and bonds tend to rise noticeably in the run-up to Fed meetings
• Expectations, positioning and profit-taking drive the recurring dynamics
The recurring pattern before Fed meetings
Before the Federal Reserve’s monetary policy decisions, the markets often see the same picture. Stocks and bonds increase in advance, before a decision has even been made.
As Bloomberg reported, citing data from Citigroup, both the S&P 500 and U.S. Treasury bonds posted weekly gains in six of the eight Fed meetings included in the analysis. According to the report, strategists even expect that a rally in government bonds can continue at least until the actual meeting day. What is striking is that this movement does not only develop with the decision, but usually begins days before.
Why the rally often takes place before the decision is made
The basis for the phenomenon called “Pre-FOMC Drift” is provided by a study by the Federal Reserve Bank of New York. The authors show that a significant portion of stock returns arise around Fed meetings in advance.
Specifically, the S&P 500 rises on average by around 49 basis points in the 24 hours before a decision. On average, little happens after publication. The study notes that the returns after the announcement are on average close to zero, while a stable upward movement can be observed beforehand.
This suggests that markets are reacting not to the decision itself, but to what they expect in advance. This effect is reinforced by the special communication situation. In the days before a meeting, central bank representatives no longer comment on monetary policy. At the same time, expectations and assessments are converging in the market. The result is a movement that builds up before the actual event.
When uncertainty disappears: The so-called “VIX crush”
In addition to the prices, the behavior of the markets is also changing beneath the surface. The New York Fed study shows that volatility tends to be lower in the hours before a decision than on normal trading days. It only increases significantly when the decision is published.
This creates a clear picture for market participants. Before the decision is made, uncertainty is compressed to a certain extent. Positions are built without any new information being added. With the announcement, this tension suddenly dissolves. Trading volume and fluctuations increase, while the actual price effect often remains limited.
The data cited by Bloomberg also fits this picture. Falling yields on government bonds and rising stock prices in advance indicate that expectations are becoming increasingly clear and are being incorporated into prices.
“Buy the Rumor, Sell the News”
A look at the well-known stock market adage “Buy the Rumor, Sell the News” helps to make this dynamic more tangible. The idea behind it is simple: Investors react early to expectations and start buying before news is officially confirmed – they are, in a sense, trading on rumors. Early buyers are driving prices higher before any official confirmation is made. Once the news is published, many take advantage of this opportunity to take profits.
This exact pattern can also be seen around Fed meetings. Expectations are priced in in advance. With the decision itself, the focus shifts. New buyers are often missing, while existing positions are partially reduced. Even positive signals do not necessarily lead to further rising prices.
Benedict Kurschat, editorial team at finanzen.net
