Macro-news releases can have large implications for asset markets and the economy. Only accredited news outlets are typically given pre-release access to such information. Recent investigations have identified evidence of information leakage before the end of the embargo period. The authors analyze informed trading that occurs during embargoes of Federal Open Market Committee (FOMC) announcements. They find dollar profits ranging from US$4.5 million to US$210.5 million for lockup-related informed trades made ahead of FOMC surprise announcements.
What’s Inside?
The authors analyze trading during embargo periods related to macro-news announcements, focusing on surprise Federal Open Market Committee (FOMC) announcements. Using high-frequency data and E-mini Standard & Poor’s (S&P) 500 futures as their test instruments, they find robust evidence of informed trading during these embargo periods. The authors estimate that dollar profits related to such activities range from US$4.5 million to US$210.5 million.
How Is This Research Useful to Practitioners?
The authors’ findings should be troubling to practitioners. Their main finding is that some market participants can trade with an information advantage over other market participants before the release of key macroeconomic information. They find robust evidence of informed trading related to FOMC announcements across several markets, and they find that the information contained in the lockup trading predicts the market reaction to the actual release of the FOMC statements. The magnitude of the profits from such activities is nontrivial; the authors estimate the high-end profits to be more than US$200 million.
These results are found only during FOMC announcement embargoes. Specifically, the authors find no evidence of informed trading before FOMC news embargoes or before surprise announcements by such other government agencies as the Department of Labor and the Bureau of Economic Analysis. They argue that these other announcements contain information of similar value to market participants as that of the FOMC announcements.
How Did the Authors Conduct This Research?
The authors investigate the federal funds target rate in the FOMC announcements. They use the E-mini S&P 500 futures (ES) data to test their hypothesis because the ES data are available for trading before most macro-news releases and have sufficient liquidity to minimize both trading costs and price impacts.
The tests the authors use depend on distinguishing and isolating surprise announcements. It is important, therefore, for the authors to be able to measure pre-release market expectations. With respect to the federal funds target rate, they use the implied interest rate from federal funds futures traded on the Chicago Mercantile Exchange as a proxy for market expectations.
The authors conduct two tests. The first test examines whether information in macro-news available to some traders explains pre-announcement market activities—similar to the studies on equity analysts’ tipping—by attempting to identify order imbalances in the test instrument. This order imbalance is defined as the difference between buyer-initiated and seller-initiated trading volumes divided by total trading volume. The authors find evidence of informed trading activity before FOMC surprise announcements, and this activity is concentrated in the window immediately preceding the scheduled release.
The second test is constructed from the perspective of uninformed market participants. In this exercise, the authors examine whether pre-release order imbalances can predict the reaction of market prices to the actual FOMC announcements. They find a significant association between abnormal order imbalances observed during FOMC embargoes and subsequent policy surprises.
Abstractor’s Viewpoint
The integrity of financial markets is called into question when some market participants can systematically trade with an informational advantage over others. The authors’ findings suggest that such trading does occur, with profits potentially in the hundreds of millions of dollars. If these results are indeed robust, new measures must be implemented to ensure that the playing field is level. Otherwise, such activities would lead to long-term damage to our financial markets.