The Effect of the Federal Reserve on the Stock Market: Magnitudes, Channels and Shocks

We survey and extend work on the Federal Reserve's effect on the stock market focusing on three empirical facts: The effect of monetary policy surprises in a narrow window around FOMC announcements, the pre-FOMC announcement drift, and the FOMC cycle in stock returns. We discuss the magnitude of the Fed's impact (directional effects or effects on average stock returns), the types of shocks coming from the Fed (pure monetary policy shocks, reaction function news or information about the Fed's view of the economy) and the asset pricing channels through which effects emerges (equity premia for news from the Fed, or changes to yields, equity premia or expected dividends). We also consider the information transmission channels for information to emerge. The Fed's effect on the stock market is large, even for average stock returns earned over periods of several decades. Fed-induced changes to both yields and equity premia play substantial roles, with less direct evidence available regarding cash flows. For stocks, reaction function news appears more important than Fed information effects. Informal information flows outside announcements windows are important.