Friday, July 08, 2005

Can Words Move the Market?

Have you ever wondered when a talking head on TV says: "The Federal Reserve's comments on inflation have driven down the market today" if they aren't just saying things that sound reasonable but really the market was reacting to something else? I mean the central problem is you never can take two copies of the exact same market, give them two sets of Fed comments and then contrast their different responces. Well you couldn't have exactly that senario but something very similar unfolded one day last May. In the same day the Fed released two different statments! They just messed up, first releasing a (slightly) wrong statment, and then a couple hours later relasing a new corrected statment. Unfortunatly the story didn't quite unfold perfectly. The corrected statement was released after the close of the major markets, but from the reporting of the incident it sounded like most people knew about the mistake by 3:15 or so. Anyway details follow:

The story:

On the 3rd of May at ~2:10 the Fed released their comment on raising interest rates then ~4:50 they said they mistakenly forgot to add a sentence that said that long term dangers of inflation were not that great. Initially I think the market took the omission to mean that long term inflation wasn't a worry at all, so the market shot up. Then after the traders realized there had been a mistake it dropped back. You can see distinctive signals in the market data. It looks like the words influenced the markets about .5%. Thus words can change market valuation on the order of $100 Billion. It would have been good to have data on volume too, but still it's facinating. (Incidently it is amazing how closely the Dow and NASDAQ track each other.)

The data:

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