It’s What’s Priced Into the Stock Market that Counts

Periodically I try to make the point that forecasting the economy or an investment doesn’t matter unless you make the forecast both accurately and before it is priced in to the markets. Sometimes markets are surprised by events or changes. Other times markets are ahead of the curve, so the actual events don’t stir markets. One good example of markets pricing in changes before they occur is the bond market.

This post describes a new study that found the bond markets tend to price in changes in Fed policy about six months before the Fed actually makes a change. Speeches by and interviews with Fed officials apparently are followed closely by bond traders and cause them to change their portfolios.

Traders and investors start pricing in changes in the central bank’s overnight target rate as much as half a year before the change takes place, according to a National Bureau of Economic Research paper published this week.

“The market prepares for [Federal Open Market Committee] announcements much farther in advance than had previously been demonstrated” in prior studies, Danish researchers Dick Van Dijk, Robin Lumsdaine and Michel van der Wel wrote. “We find strong evidence of anticipatory set-up, going back as far as six months prior to an FOMC meeting,” they noted.