Fearing the Fed: How Wall Street Reads Main Street

Abstract

We provide strong evidence of a countercyclical sensitivity of the stock market to major macroeconomic announcements. The most notable cyclical variation takes place within expansions: sensitivity is largest early in an expansion and essentially zero late in an expansion. By exploiting the comovement pattern between stock returns and bond yields around announcements, we show that the stock market sensitivity is large when the cash flow component of news is least offset by news about future risk-free rates. We propose a simple New Keynesian model which links this asset pricing evidence to monetary policy responsiveness.

Keywords: Cyclical return variation, macroeconomic news announcements, monetary policy expectations, news decomposition.

JEL Classification: G12, E30, E40, E50