What is 'Announcement Effect'

Announcement effect broadly refers to the impact that any type of news or public announcement — especially when issued by government or monetary authorities — has on financial markets. It is most often used when speaking of a change in security prices or market volatility that results directly from a piece of significant news or a public announcement. It also could refer to how the market would react upon hearing the news that a change will occur at some point in the future.

Breaking Down 'Announcement Effect'

The announcement effect assumes that the behavior of systems (such as financial markets) or people (such as individual investors) can change merely by announcing a future policy change or divulging a newsworthy item. The news may come in the form of a press release or report. Topics that can spur investor reaction, either positively or negatively, are things like company mergers and acquisitions (M&A); growth in money supply, inflation, and trade figures; changes in monetary policy, such as a hike or cut in a key interest rate; or developments that affect trading, like a stock split or change in dividend policy. For example, if a company announces an acquisition, then its stock price may rise. Or, if the government says that gasoline tax will increase in six months, then commuters who drive to work every day might look for other modes of transportation, or spend less money now in anticipation of the greater expense going forward.

News released by central banks can have an especially dynamic and complicated effect on financial systems. Information about monetary policy or real factors, like productivity, can hugely affect the markets for goods, equity, housing, credit, and foreign exchange. Even neutral news about monetary policy can induce cyclic or boom-and-bust responses. Moreover, central bank announcements can induce rather than reduce volatility.

The Announcement Effect and the Federal Reserve System (the Fed)

An announcement from the Federal Reserve about a change in interest rates generally correlates directly to stock prices and trading activity. For example, if the Fed raises interest rates, then stock prices are liable to fall. Prior to 1994, monetary policy objectives for the federal funds rate — any outcome of the Federal Open Market Committee (FOMC) meeting — were strictly confidential. At its February 1994 meeting, the FOMC decided to modify the federal funds rate target, which it had not done for two years. To ensure that this important policy decision was communicated clearly to the markets, the FOMC decided to disclose it via public announcement. Thus began the custom of "Fed days” — when the FMOC makes announcements about interest rates — which now is shared by numerous central banks. A practical outcome of sharing the decisions made at FOMC meetings is a kind of announcement effect — which, in this case, means that because the market knows what to expect from the Fed, the behavior of market rates can adjust accordingly with little or no immediate action by the trading desk. In general, traders eagerly await announcements that come from the Federal Reserve. On Fed days, trading volume is notably higher; and on the day preceding a Fed day, trading is usually relatively calm.

Good News, Bad News, and Market Surprises

Economists, technical analysts, traders, and researchers spend a great deal of time trying to predict the effect of news or public announcements on stock prices in order to discern, among other investing strategies, the wisdom of switching between asset classes or moving in and out of the market altogether. Although investment professionals often disagree on the finer points of technical theory, they do agree that the stock market is driven by news. Researchers have suggested that bad news has a larger impact on markets than good news; and good news does not lift the market as much as bad news depresses it. Also, bad news during a bear market has a bigger negative impact than bad news during a bull market; and negative surprises often have greater impact than positive surprises.

Whether negative or positive, the announcement effect always carries the potential to cause drastic changes in stock prices or other market values, especially if the news is a surprise. For a taste of just how volatile a reaction the markets can have to unexpected commentary, take a look at the graphic below. It shows that the dollar swung wildly between gains and losses on July 19, 2018, after President Donald Trump publicly criticized the Federal Reserve for raising interest rates — a comment that broke with the long tradition that United States presidents do not interfere with the business of the Fed.

Dollar Volatility July 19, 2018

In order to minimize surprises and defend against radical reactions like the one pictured above, companies and governments often selectively leak, or hint at, announcements before they actually occur. Leaking critical news can allow the market to find equilibrium, or to “discount the stock” — that is, to incorporate the unexpected news into the price of a stock. For instance, if a company's earnings are especially greater than usual one quarter, it might choose to leak the information to help ease the pressure for an unsustainable price spike at the time of the official earnings release. Likewise, on its Fed days, the Federal Reserve discloses what policy changes it might make before it actually makes them, so that the market can adjust smoothly to the new information.

RELATED TERMS
  1. Federal Funds Rate

    The federal funds rate is the interest rate at which a depository ...
  2. Open Market Operations - OMO

    Open market operations refer to the buying and selling of government ...
  3. Positive Carry

    Positive carry is a strategy of holding two offsetting positions ...
  4. Federal Reserve System

    The Federal Reserve System is the central bank of the United ...
  5. Monetary Accord Of 1951

    The Monetary Accord of 1951 was an agreement between the U.S. ...
  6. Policy Mix

    The combination of fiscal and monetary policy a nation's policymakers ...
Related Articles
  1. Insights

    How Federal Open Market Committee Meetings Drive Rates And Stocks

    Janet Yellen's first Federal Open Market Committee (FOMC) meeting - and its aftermath - is an important bellwether for the immediate future of the U.S. economy.
  2. Investing

    Can Good News Be A Signal To Sell?

    Sometimes positive announcements can mean bad news for a stock. Find out why.
  3. Personal Finance

    How the Federal Reserve Affects Your Mortgage

    The Federal Reserve can impact the cost of funds for banks and consequently for mortgage borrowers when maintaining economic stability.
  4. Insights

    The Top Sites for the Latest Stock Market News

    Along with online sources, active traders pay close attention to other media – like live TV, Twitter and newsletters to benefit from news-based trading.
  5. Insights

    As Expected, FOMC Leaves Rates Unchanged

    The FOMC left rates unchanged at its latest meeting, sees "improved" sentiment.
RELATED FAQS
  1. What are the implications of a low federal funds rate?

    Find out what a low federal funds rate means for the economy. Discover the effects of monetary policy and how it can impact ... Read Answer >>
  2. How do open market operations affect the U.S. money supply?

    Formulating a country's monetary policy is extremely important when it comes to promoting sustainable economic growth. More ... Read Answer >>
  3. Market operation and its effect on Money Supply

    Understand how open market operations affect the supply of money in the economy and learn the specific ways the Federal Reserve ... Read Answer >>
  4. What is the relationship between inflation and interest rates?

    As interest rates are lowered, more people are able to borrow more money, causing the economy to grow and inflation to increase. ... Read Answer >>
Trading Center