Front running Fed-Day’s Eve

Some kids just can’t wait for Christmas morning, and beg for a present on Christmas Eve. For traders, Fed Day — the day the Federal Open Market Committee announces its decisions on rates and asset purchases — is no different. And according to an update this week of research from the New York Fed, the kids are now getting antsy even earlier.

In 2013, David Lucca of the New York Fed and Emanuel Moench of Germany’s Bundesbank published a paper showing that, between 1994 and 2011, there was a statistically significant rise in excess returns to almost every major international equity index during the 24-hour period before a meeting of the FOMC. The rise began on the afternoon before Fed Day:

The Fed-Day's Eve bump, they explained, could be due to “attention re-allocation” — poor planning. Traders, busy with other things until the day before, then quickly placed their bets.

Lucca and Moench recently returned to their research, with a post for the New York Fed’s Liberty Street Economics blog. They looked at the period from April 2011 to June 2018, when press conferences began accompanying some Fed meetings. The analysis separated the statement-only meetings from those including a press conference. Excess returns came prior only to meetings when Saint Nick (the Fed chair) spoke.

The new data also revealed that the timing of the “drift” upward had shifted to begin earlier in the morning on the day prior, indicating that investors became wise to the opportunity. The Fed-Day’s Eve bump has become the Fed-Day’s Eve’s Morn bump.

Lucca and Moench were on to this attempt to front-run the rise (emphasis ours):

But an attention reallocation hypothesis still begs the question as to why some sophisticated investors would not attempt to profit from the positive returns. In fact, the timing of the post-2011 returns suggests that such activities may have occurred. Pre-FOMC returns were positive in the post-2011 sample on press conference days from the open of the day before the FOMC, while cumulative returns were positive starting only in the afternoon of the day before the announcement in the pre-2011 sample. This suggests that some investors could be attempting to profit from the pre-FOMC returns, pushing prices up earlier than before. If this were the reason for the shift in the timing of the returns, such a process would imply that the pre-FOMC returns should eventually disappear.

Once an opportunity goes mainstream, is it still an opportunity? This year, will the pre-FOMC bump begin on Fed Day’s Eve’s Eve? If everyone thinks that everyone else might celebrate early, our guess is yes.

This December, try not to open your presents too early. And be sure to put out cookies for St. Jay Powell.