How news affects markets
Tyler Cowen linked to a new NBER study by Scott R. Baker, Nicholas Bloom, Steven J. Davis, and Marco C. Sammon, which looks at the response of asset prices to various types of news. Here I’ll discuss the paper’s abstract:
We examine next-day newspaper accounts of large daily jumps in 16 national stock markets to assess their proximate cause, clarity as to cause, and the geographic source of the market-moving news. Our sample of 6,200 market jumps yields several findings. First, policy news – mainly associated with monetary policy and government spending – triggers a greater share of upward than downward jumps in all countries.
I’m not surprised that monetary policy is important, or that the effects are asymmetric. While one can find occasional examples of markets falling sharply on monetary policy announcements, as in December 2007, major changes are usually in the upward direction. This is because bad monetary policy generally involves errors of omission—the central bank fails to adjust its policy rate when the natural rate of interest is falling (as in mid-2008.) When the central bank does make a major move, it generally helps the situation. The problem, of course, is that central banks are too passive; too unwilling to move when economic conditions change.
Second, the policy share of upward jumps is inversely related to stock market performance in the preceding three months. This pattern strengthens in the postwar period.
Beneficial policy adjustments are less likely to occur if the economy (and the markets) has previously been doing well.
Third, market volatility is much lower after jumps triggered by monetary policy news than after other jumps, unconditionally and conditional on past volatility and other controls. Fourth, greater clarity as to jump reason also foreshadows lower volatility.
A monetary policy announcement often helps to clarify the situation. Other shocks, such as the failure of Lehman Brothers, make the situation even more confusing.
Clarity in this sense has trended upwards over the past century.
When I studied monetary policy in the 1930s monetary policy, I noticed that the policy environment was far more unstable than today, and also that the stock market was far more volatile than today. The average daily move in the DJIA was around 2%.
Finally, and excluding U.S. jumps, leading newspapers attribute one-third of jumps in their own national stock markets to developments that originate in or relate to the United States. The U.S. role in this regard dwarfs that of Europe and China.
This fits in with David Beckworth’s claim that the Fed is a monetary superpower due to the dollar’s role in the global economy. (Eurozone GDP is similar in size to the US GDP, but the ECB is far less influential.)
PS. There are schools of thought on both the left and the right that claim monetary policy doesn’t matter, that it’s just swapping base money for T-bills. They have no explanation for these empirical facts, and presumably either deny them or ignore them.
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19. April 2021 at 11:58
> When the central bank does make a major move, it generally helps the situation.
Why does an increase in stock prices mean that the situation has improved? It seems to me to be just as likely that central banks tend to reduce interest rates, leading to higher present values of future cash flows. It’s not obvious to me that this is good (or bad) without more context.
19. April 2021 at 12:55
Fascinating though expected results.
PS you wrote: “When I studied monetary policy in the 1930s,”
I didn’t know you were that old!
19. April 2021 at 13:30
The problem I have with this and other papers of the ilk is that it is pretty much useless for portfolio management. Perhaps high frequency traders build some of this into their algorithms but I tend to ignore all of this as just chatter. I would like to some of these folks run a real-life portfolio with their own money on the line.
19. April 2021 at 14:28
PG, It doesn’t guarantee the situation has improved, but that’s generally the case. Monetary stimulus doesn’t always reduce long term rates. But stocks often rise even if long term rates don’t fall.
Stoneybatter, In an earlier life.
Alan, I fail to see how that’s a “problem”, given that these papers are not trying to predict asset prices.
19. April 2021 at 16:28
Does government spending announcements causing a positive jump run contrary to monetary offset being true? Isn’t it evidence that fiscal stimulus works?
19. April 2021 at 21:55
Alan, the bit about volatility seems actually pretty useful to me for running a portfolio.
If you can predict volatility, at least a bit, managing leverage and liquidity becomes easier.
20. April 2021 at 06:09
re: “When the central bank does make a major move, it generally helps the situation.”
Yes, if you know how to interpret it:
On the day the market bottomed:
That’s B.S.
Bottom’s in.
Mar 23, 2020. 10:34 AM
Link
Margin Call: The Story Of A Historic Week – The Heisenberg
Bottom for stocks, not the economy. It will decouple.
Mar 23, 2020. 10:33 AM
Link
We Likely Saw The Bottom – Michael A. Gayed, CFA
The bottom’s in.
Mar 23, 2020. 10:28 AM
Link
Sentiment Speaks: Many Did Not Believe We Would See 2200SPX Again, And Many Will Not Believe What I Am Thinking Now – Avi Gilburt
My take, with the FED’s recent moves, the bottom is now in.
Mar 23, 2020. 10:26 AM
20. April 2021 at 06:12
re: “the central bank fails to adjust its policy rate when the natural rate of interest is falling (as in mid-2008.)”
link: Daniel L. Thornton, Vice President and Economic Adviser: Research Division, Federal Reserve Bank of St. Louis, Working Paper Series
“Monetary Policy: Why Money Matters and Interest Rates Don’t”
bit.ly/1OJ9jhU
Thornton: “the interest rate is the price of credit, not the price of money (i.e., the price level.)”
#1 Gibson’s Paradox: “observation that lower prices were accompanied by a drop—rather than a rise—in interest rates”
#2 Interest Rate Fallacy: “monetary policy is easy when interest rates are low and monetary policy is tight when interest rates are high”
# 3 Paradox of Thrift: “The paradox states that an increase in autonomous saving leads to a decrease in aggregate demand and thus a decrease in gross output which will in turn lower total saving.”
20. April 2021 at 06:26
The drop in interest rates during the 4th qtr. of 2008 had nothing to do with monetary flows, AD, volume times transactions’ velocity. In fact, the establishment of the IOeR remuneration rate, 2008-10-09 0.75, 2008-10-23 1.15, 2008-10-29 0.65, 2008-11-06 1.00, 2008-12-16 0.25, destroyed velocity.
Stocks didn’t turn until March 2009, when money flows finally turned up.
20. April 2021 at 06:39
Economists are in fact, running the economic engine, the savings->investment process, in reverse. Banks are “black holes”. It is an allusion that banks loan out existing deposits.
As Dr. Philip George states: “The velocity of money is a function of interest rates.”
So, AD is being funded by money products, not savings’ products. So, we need an infrastructure stimulus just to keep things moving.
Otherwise short-term money flows, volume times transactions’ velocity (proxy for real output), peaks in May and long-term money flows (proxy for inflation), peak next January.
20. April 2021 at 08:14
Mark, It could be. I’d like to see the size of the effect, and where it occurs. Monetary offset doesn’t apply to many developed countries, which lack their own independent monetary policy.
20. April 2021 at 08:19
Great post. I spent some time using google news And their API to look at this. It was a miserable failure. I gave up. Glad someone figured it out.
21. April 2021 at 04:13
I can’t think of a major media outlet besides the Economist that has even mentioned AIT in the past year. Granted, I don’t watch TV and my memory isn’t trustworthy, but I feel like the “market” has responded to the Powell Fed by maintaining a certain degree of mostly upward trending stability (a permanently high plateau?).
Most current news stories are about asset price volatility–Gamestop,etc.. or that 2×4’s cost 3 times what they cost last year. The Fed seems to be more aware of its power, and generally indifferent to market froth. There will be media hysteria through this year about specific price points for some types of labor and commodities but I hope that the governors ignore that.
21. April 2021 at 06:03
The announcement of QE2 ($600 billion of Treasury bills, bonds, and notes), was one of the most powerful examples of the FED’s communication’s impact (the failure of QE1 to stimulate the economy).
The economy continued to falter (the nsa CPI fell in Nov and Dec), yet stocks surged higher (the Nasdaq 100 rose from 1818.8 on 8/13 to 2225.72 on 12/30) due to a rise in inflation expectations. 10yr breakevens rose from 1.49 on 8/24/2010 to 2.64 on 4/8/2010
21. April 2021 at 06:13
Scott,
John Cochrane is worried. I would really appreciate your thoughts!
https://johnhcochrane.blogspot.com/2021/04/inflation-expectations.html
21. April 2021 at 09:12
Todd, John asks:
“And we don’t even have the speeches — just what does the Fed even promise to do if inflation breaks out?”
They’ve told us that they’ll tighten monetary policy enough to keep inflation at an average rate of 2% over the long term. Time will tell if they keep that promise.
21. April 2021 at 09:57
John is as appallingly vacuous as all the others. Marcus Nunes has a good article on inflation: “On Headline & Core Inflation”
https://marcusnunes.substack.com/p/on-headline-and-core-inflation?
21. April 2021 at 14:30
I’ll make a heavily qualified defense of Cochrane’s position—after all, this is the Bad Blog.
Cochrane wants everyone to stay on their toes and raise a ruckus if CPI, unemployment rate, bond spreads, and wages are all pointing towards significant* inflation. My guess, and I’m happy for a Sumner Smackdown, is that the Fed won’t move even if we have 3 quarters of inflation that look like this: 2.2, 2.4, 2.7
But, after the quarter with 2.7 Powell will start talking about tightening–and they’ll vote for a 25 basis point move.
And if we have 3 quarters of 1.9, 2.0, 1.9 we should expect no action, no matter what’s happening in all the FRED charts.
*And what is significant? A few years of inflation that matches 1988 to 1991 maybe? Or 98 to 2000?
21. April 2021 at 16:58
Given that money is nearly neutral, a better way to interpret this study, which confuses causation and correlation, is to say the Fed during boom times makes policy decisions that affect day traders (more than half of the time the stock market is trending up anyway). That’s all. How long does the Fed effect last? A few hours. That’s how long money is not neutral. Sumner is impressed by this? He’s probably impressed by PR releases that cause a temporary jump in stock prices too.
22. April 2021 at 08:56
Monetary policy is a scam.
The banks borrow from American tax payers at zero percent to cover their 10% obligations, which reduces their risk to essentially zero. If the loans fail, and threats to sue are ignored, they simply write it off and borrow more. Only the idiots actually file bankruptcy. Smart money knows that if you ignore them they won’t do anything, unless you owe them millions. Why would they, when they can simply go back to the well.
And low and behold, access to this ponzi club is exclusive. You and I cannot create a bank and borrow from the American tax payer at zero percent.
The only thing holding up the U.S. economy is the reserve currency factor. Without that, the currency would be nearly worthless.
22. April 2021 at 09:47
“In statistics and econometrics, a distributed lag model is a model for time series data in which a regression equation is used to predict current values of a dependent variable based on both the current values of an explanatory variable and the lagged (past period) values of this explanatory variable” — Wikipedia
The concentration of price points in the lagged model has already passed. Inflation will decelerate from this point forward. It will fall fast beginning in Feb 2022.
22. April 2021 at 11:36
David, Keep in mind that the Fed is not targeting the CPI.
Ray, LOL, when you shoot arrows with a blindfold on, it’s not likely that many will hit their target.
22. April 2021 at 18:58
It is interesting how few economists study the relationship between the economy and the stock market. There are some who claim that there is little if any relationship, when the reality is quite the opposite. The vast majority of changes in stock prices are due to changes in economic growth expectations.
Also, it has surprised people so far, and even surprised me, how high the correlation is between 1 year Treasury yields and the S&P 500 earnings yield. It is 0.745, which is the second highest correlation I’ve seen in macroeconomic data. Of course, the 1 year Treasury rate tracks the Fed Funds rate extremely closely.
The only macro correlation I’ve seen that’s higher is that between the Fed Funds rate, and core PCE inflation, which is about 0.80.
23. April 2021 at 05:53
re: “The vast majority of changes in stock prices are due to changes in economic growth expectations”
Economists are arrogant. They’ve learned their catechisms.
Take the NYT: “News of the tax provisions appeared to unnerve investors on Thursday, with stock markets giving up gains as investors absorbed details of Mr. Biden’s capital gains tax plans. The S&P 500 closed down 0.92 percent.”
That was just a news trigger. The rates of change in the economy and inflation have already peaked and are headed lower.
@Michael Sandifer: It’s interesting to note that 1yr Treasury yields represents the “money market” yield, The money market is differentiated by its position on the yield curve (i.e., short-term borrowing & lending with original maturities from one year or less).
As George Selgin told us: Paying interest on reserves is illegal at these rates of remuneration (rates higher on the front-end segment of the money market retail and wholesale funding yield curve, or the FRB-NY trading desk’s synthetically inverted yield curve, viz, a credit control device anchored on the front-end). This Romulan Cloaking Device exceeds the level of short-term interest rates which was explicitly illegal per the FSRRA of 2006.
23. April 2021 at 06:07
@Ray Lopez re: “A few hours. That’s how long money is not neutral.”
You’ll say anything to get attention. The neutrality of money is a function of the distributed lag effect of monetary flows, volume times transactions’ velocity. It is demonstrably a function of (the gap between) short-term money flows (proxy for real output), vs. long-term money flows (proxy for inflation).
Note: “Neutrality of money is the idea that a change in the stock of money affects only nominal variables in the economy such as prices, wages, and exchange rates, with no effect on real variables, like employment, real GDP, and real consumption.” Wikipedia
23. April 2021 at 06:15
The COVID-19 pandemic is prima facie evidence. The wider the gap between Roc’s in money flows (short-term exceeding long-term), the greater the impact on real variables of any injection of new money.
23. April 2021 at 08:52
@Michael Sandifer says “The vast majority of changes in stock prices are due to changes in economic growth expectations” – Wrong. (internet): Dimson, Marsh and Staunton (DMS) studied the relationship between long-term stock market returns and long-term GDP growth.1 Their sample included a cross-section of 21 countries with equity return and GDP growth data from 1900 to 2013. Fifteen of the 21 countries were in Europe, so the sample largely represented a similar economic history. The DMS researchers found a modest negative correlation between real (inflation-adjusted) equity returns and per capita GDP growth, and they found a modest positive correlation between real equity returns and aggregate GDP growth. The results were mixed and the evidence linking equity returns to GDP growth was weak, surprising many investors and economists.
@Spencer Bradley Hall – wrong. The QTOM is an accounting identity. Since velocity is not constant, it explains nothing. Try harder next time.
@SS–you’re in form, as obscure as always. And misunderstood.
Bonus trivia: just released today, an MIT model that finds C-19 virus is as infectious at 6 feet as at 60 feet. The key apparently is the amount of C19 virus in the air, not the distance. Hence low transmissions inside of filtered airplane cabins, high transmission insider of crowded bars of stale air.
23. April 2021 at 08:55
Steve Hanke “It’s the money supply stupid. The money supply determines the course of nominal gDp”.
Jerome Powell should be fired. He failed to solicit comments and obtain consensus in the Federal Register. “Powell: “the correlation between different aggregates [like] M2 and inflation is just very, very low”.
Powell is vacuous. So is William Barnett.
23. April 2021 at 08:56
@Michael Sandifer – an amplification to my previous post. If you’re saying that PE expansion can occur due to investors anticipating higher growth, and this pushes up stock prices, then you’re kind of right, but PE expansion can occur from any ‘enthusiasm’ by investors. They can anticipate higher growth or simply anticipate more people will like stocks. Growth is a red herring in this analysis, and explains nothing. Again the DMS study (which perhaps is biased by WWI and WWII in Europe but is still the best evidence we have).
23. April 2021 at 09:02
Ray Lopez: re: “Since velocity is not constant, it explains nothing”
I predicted the 4th qtr. 2008 crash. I predicted the bottom in March 2009. I denigrated Nassim Nicholas Taleb’s “Black Swan” theory (unforeseeaable event), 6 months in advance and within one day. I predicted both the flash crash in stocks on May 6, 2010 and the flash crash in bonds on October 15, 2015.
The Stock Market Was Rocked by a Mysterious ‘Flash Crash’ Five Years Ago. What You Need to Know. | Barron’s
“Diminishing market depth and a surge in volatility were both on display Oct. 15, when Treasuries experienced the biggest yield fluctuations in a quarter century in the absence of any concrete news. The swings were so unusual that officials from the New York Fed met the next day to try and figure out what actually happened”
Link: “Diminished Liquidity in Treasury Market” or:
acrossthecurve.com/…
“(Bloomberg) — Trading Treasuries keeps getting tougher and tougher.
For decades, the $12.5 trillion market for U.S. government debt was renowned for its “depth,” Wall Street’s way of talking about a market’s ability to handle large trades without big moves in prices. But lately, that resiliency has practically vanished — and that’s a big worry.”
You try harder.
No money stock figure standing alone is adequate as a guide post for monetary policy. That’s why you use monetary flows, volume times transactions velocity.
23. April 2021 at 21:27
Obviously, average wages track inflation, and it’s interesting because it may mean it’s possible to scrape online representative advertised wage data for use as an inflation proxy.
23. April 2021 at 22:09
Some news is ignored:
Jerome Powell ““When you and I studied economics a million years ago M2 and monetary aggregates seemed to have a relationship to economic growth,” Powell said, referring to one main measure of the money in public hands. “Right now … M2 … does not really have important implications. It is something we have to unlearn I guess.”
DAH. An increase in non-M1 components destroys velocity.
24. April 2021 at 08:06
Powell ” “there was a time when monetary policy aggregates were important determinants of inflation and that has not been the case for a long time”
That’s wrong. There is “No Fool in the Shower” Monetary flows, volume times transactions’ velocity, proxy for inflation, bottomed
02/1/2020 ,,,,, 0.03 low…and rose steadily to 04/1/2021 ,,,,, 1.54
25. April 2021 at 07:03
Does this reveal an EMH problem? You know that the Fed tends to act too slowly. Presumably others know that too and that knowledge will be reflected in prices. In other words, since the Fed’s tardiness is predictable, why wouldn’t its tardy action already be reflected in prices? And, if it’s not, then those like you who know about their tardiness will have found a way to beat the market regularly.
25. April 2021 at 08:13
Carl, The Fed’s behavior is only partly forecastable, so I’m not sure it’s a problem for the EMH.
25. April 2021 at 08:47
Powell doesn’t know money from mud pie.
““This change means that savings deposits have had a similar regulatory definition and the same liquidity characteristics as the “TRANSACTION ACCOUNTS” reported as “Other checkable deposits” on the H.6 statistical release since the change to Regulation D.”
But the turnover ratio of the sub-component: “total checkable deposits” to “other checkable deposits” is 95:1.
No money stock figure standing alone is adequate as a guide-post for monetary policy.
WSJ 6/28/1983: “The experimental measures are designed to resolve some of the confusion by isolating money intended for spending, from the money held as savings. The distinction is important because only money that is spent-so-called “true money” – influences prices and inflation”
He echoed the same thing Greenspan did:
“In July 1993, Chairman Greenspan informed Congress that the monetary aggregate, M2, had been “downgraded as a reliable indicator of financial conditions in the economy, ” reflecting the fact that “the historical relationships between money and income and between money and the price level [had] largely broken down.”
Federal Reserve Bank of San Francisco | Is It Time to Look at M2 Again? (frbsf.org)
Jerome Powell should be fired. He failed to solicit comments and obtain consensus in the Federal Register. “Powell: “the correlation between different aggregates [like] M2 and inflation is just very, very low”.
Powell is vacuous. So is William Barnett of Divisia Monetary Aggregates. Divisia Inside Money Aggregates – The Center for Financial Stability
Neither applies the distributed lag effect of monetary flows, volume times transactions’ velocity, to AD. Contrary to Nobel Prize–winning economist Milton Friedman and Anna J. Schwartz’s “ A Monetary History of the United States, 1867–1960 “ monetary lags are not “long and variable”. The distributed lag effects for both real output and inflation have been mathematical constants for over 100 years.
Powell: “there was a time when monetary policy aggregates were important determinants of inflation and that has not been the case for a long time”
Not so. Over longer periods, the U.S. $ indices reflect FOMC ease or tightness.
As an example, the price of oil troughed in Jan 2016 as long-term money flows fell by 80 percent from 1/2013 to 1/2016. Oil fell by 70 percent during the same period. The Trade Weighted U.S. Dollar Index: Broad, Goods and Services rose from 1/2/13 to 1/4/16 from 90.6941 to 114.1596. Gold fell by 57 percent from 1681.50 to 1072.70. And the real rate of interest rose dramatically off 2012’s lows (from -0.87 on 12/10/2012 to 0.86 on 9/10/2013).
The increase in non-M1 components destroys the velocity of circulation. There’s no way M2 is accurate. See Dr. Philip George’s: “The Riddle of Money Finally Solved”.
And as Dr. Philip George says; ““When interest rates go up, flows into savings and time deposits increase” ( the ratio of M1 to the sum of 12 months savings ).
That destroys the velocity of circulation as banks don’t loan out deposits. It is a wholly unrecognized fact. Deposits are the result of lending/investing. All bank-held savings are lost to both consumption and investment, indeed to any type of payment or expenditure.
25. April 2021 at 08:49
Chairman Jerome Powell: “there was a time when monetary policy aggregates were important determinants of inflation and that has not been the case for a long time”
Not so. Long-term monetary flows (exclusive of the “BASE EFFECT”), volume times transactions’ velocity (proxy for inflation), peaked in April (the 10yr breakevens’ peaked @2.37% on 3/31/2021). Short-term monetary flows (proxy for real output), peaks in May (underweights Vt).
Stocks typically follow short-term money flows. The U.S. $ follows long-term money flows.
28. April 2021 at 06:28
Sumner referenced on SA
https://seekingalpha.com/article/4421560-feds-monetary-policy-playbook-run-out-of-road
28. April 2021 at 08:59
What has the FAIT regime wrought? Guaranteed soaring commodity prices and murder rates. Murder rates are an economic math equation.
29. April 2021 at 08:33
Spencer, Don’t forget the surge in Covid cases in India!
30. April 2021 at 12:28
I’m vaccinated. And I get my Covid-19 info from my father, who is an endocrinologist and was Alpha Omega Alpha in med school.
India’s a different animal. There are people there who’ve never seen a bed and will sleep on a rug even when given a bedroom in a house here.
Friedman was one dimensionally confused too, stock vs. flow. The parameters of economics are not those of mathematics – the whole in the payment’s system is much larger than the sum of its parts.
2. May 2021 at 05:41
Looking at the 1st quarterly 2021 #s, 3.8% inflation and 1.6% R-gDp, we have stagflation, business stagnation accompanied by inflation.
“Rethink 2%”
http://bit.ly/2s67De9
5. May 2021 at 07:35
CPI Jan 2019 251.712 to today 264.877
R-gDp 1st qtr 2019 113.683 to today 114.750
0.052301837 inflation
0.009385748 R-gDp
That NSA change represents stagflation
5. May 2021 at 07:43
You get a similar result using N-gDp
2021-01-01 115.564 0.036095322 growth
2019-01-01 111.538