Abstract:
The Federal Reserve faces a challenge of supporting the economy by cutting rates aggressively in downturns and potentially creating uncertainty about future output gap, inflation, and interest rates. We study how the Fed’s communication of its forward-looking policy stance affects risk premia in financial markets. We analyze private deliberations of the Federal Open Market Committee (FOMC) to elicit a nuanced policy stance beyond the current policy action. We show that more hawkish (dovish) views predict economically significant reductions (increases) in risk premia during the subsequent intermeeting period. The risk premium reaction unfolds gradually in the days after the announcement. The effect is not subsumed by the content of the FOMC statement and is distinct from the “on impact » risk-premium reduction caused by surprise rate cuts at the FOMC announcements, documented in the literature. We trace how the stance in the meeting is revealed via the Fed’s public communication, which we then tie to intermeeting movements in premia. The results highlight the role of communication in managing public risk perceptions.