FOMC risk and resolving uncertainty

 

FOMC days haver high uncertainty. We saw that yesterday. There is the unknown of what the Fed will do and say, and it becomes the focus of market attention and expectations. On these days, uncertainty is also resolved at the announcement. We may not have known what the rate increase will be with certainty, but the announcement solves this unknown. We also obtain clarification quarterly on Fed forecasts through the SEP and dot-plots. Risk is repriced on these key calendar dates.

Research has found that prior to the announcement from the FOMC, the stock market will yield higher returns without an increase in normal measures of risk. While this has been viewed as a puzzle, recent research suggests that this is excess return before announcement is associate with the resolution of uncertainty. The same behavior to a lesser extent occurs with other macro announcements and after high spikes in the VIX index. see "Premium for Heightened Uncertainty: Solving the FOMC Puzzle".

The important point is that high uncertainty exists around macro release days especially FOMC dates. Uncertainty is resolved and there is a premium with holding risky assets before the announcement. Everyone must be a macro trader around these important periods; however, holding risk is rewarded as uncertainty is resolved. Once again uncertainty is resolved and now, we have information on how to reprice assets.