How to Make Money on Fed Announcements with Less Risk

Investors could earn significant short-term gains in US and global stock markets using a simple trading strategy around the US Federal Reserve’s monetary-policy announcements, according to research by University of Notre Dame’s Andreas Neuhierl and Chicago Booth’s Michael Weber. The strategy could achieve a substantially higher return than a standard buy-and-hold investment plan, without increasing risk.

Neuhierl and Weber find gains of about 4.5 percent when investors bought or shorted markets in the roughly 40 days before and after Federal Open Market Committee (FOMC) announcements that ran counter to market expectations. Investors can make money on these “surprises,” even if they did not take positions before the announcements, the findings suggest.

Markets routinely forecast the content of FOMC announcements, which reveal the Fed’s new target interest rates, and usually react when the Fed does not act as expected. An FOMC announcement is an expansionary surprise when its new target rate is lower than the market forecasts and contractionary when it’s higher than expectations.

Share prices moved predictably ahead of and following both types of surprises, the study notes. Prices began to rise about 25 days ahead of an expansionary surprise, for about a 2.5 percent gain during that time. Before a contractionary surprise, prices generally fell. The researchers find that the movements occured in all industries except mining, where contractionary surprises tended to push share prices higher.

Share prices continued to drift in the same direction of the preannouncement movement for 15 days, ultimately producing a 4.5 percent difference between share prices after contractionary and expansionary surprise announcements.