Last year, markets were fixated on interest rates and the Fed. On days when the Fed announced interest rate decisions in 2022, markets were volatile. On the day after those decisions were announced, markets typically sold off. This year has seen a change in those trends. Markets have been much less volatile on Fed days. In addition, markets have mostly risen in 2023 on the day after the Fed announced a policy decision. In short, the market appears more comfortable with Fed policy, even as interest rates have settled at a higher level than initially expected.
What are FOMC, or “Fed days”?
The FOMC stands for the Federal Open Market Committee, which is a 12 member board within the Federal Reserve that sets interest rates and other key monetary policy. The FOMC holds eight policy meetings per year. At the conclusion of these meetings, the FOMC communicates their latest policy decisions to the market.
We can observe market reactions on and around these FOMC days, (referred to as “Fed days”), to judge what is priced into the market. In 2022, for example, markets were very volatile on Fed days. That suggests the market had a lot of uncertainty around the policy decisions the Fed was making.
Throughout last year, on the day after fed policy announcements were made, markets usually fell. Such declines suggested nervousness around Fed policy. We focus on the “day after” return, because on Fed days, policy decisions are announced at 2 pm EST. That only leaves two hours for markets to react to the latest information from the Fed. Therefore, the first full day after a Fed day gives a clearer indication of what’s priced into the market.
Fed Days in 2022 vs 2023
In looking at market reactions after Fed days in 2022, stocks fell a median of 0.94% in 2022. Such declines are evidence that after the market had time to digest the Fed’s announcements it drew a negative conclusion. Aggressive Fed policy was not priced into the market ahead of the time.
Fast forward to 2023 and we’re seeing just the opposite: markets have risen a median of 0.76% on the day after Fed days. This suggests that the market has already priced in the Fed’s current level of interest rates. If such policy wasn’t priced into the market, we’d expect to still be seeing negative market reactions on the day after a Fed day.
Markets hate uncertainty
There’s only one thing the market doesn’t really like and that’s uncertainty. Last year, there was uncertainty over how high interest rates would go. This year, even though interest rates are higher than they were most of last year, markets have been steady. This a reflection that the market has successfully priced in current Federal Reserve policy. The Fed, and interest rates, are no longer surprising the market.
One might say that markets were never scared of high interest rates in the first place. Rather, markets were just nervous about the general uncertainty around interest rates. If high interest rates by themselves were a problem for the market, we wouldn’t see stocks going up in 2023. After all, interest rates are at their highest levels in more than a decade.
Markets expect interest rates to stay elevated for the remainder of the year. So, at the moment, there appears to be little in the way of interest rates or Fed policy that is going to surprise the market. This is a good thing for investors as greater certainty for the market reduces volatility. However, it will be important to revisit the market’s interest rate expectations later in the year. 2024 could pose a renewed debate around the market’s expected path for interest rates and Fed policy.
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