Demystifying Monetary Policy Surprises: Fed Response to Financial Conditions and Wait-and-See for New Economic Data

Key Findings

This paper addresses a puzzling phenomenon in monetary economics: why are supposedly “exogenous” monetary policy surprises—measured by changes in short-term financial contracts within narrow windows around Federal Open Market Committee (FOMC) announcements—partially predictable using pre-meeting economic and financial information?

The Puzzle

Standard identification of monetary policy shocks assumes that high-frequency movements in interest rate futures around FOMC announcements capture the unexpected component of policy decisions. However, researchers have documented that these “surprises” can be partially predicted by information available before the meeting.

Our Explanation

We propose a new explanation for this predictability:

1. Response to Financial Conditions: The Federal Reserve targets economic variables by responding primarily to financial market conditions.

2. Wait-and-See Approach: The Fed adopts a “wait-and-see” stance toward recent economic data.

3. Market Expectations: When markets expect the Fed to target economic variables directly, this creates the predictable component of policy surprises.

Empirical Evidence (2000–2019)

Using daily-frequency economic and financial data, we find three pieces of supporting evidence:

1. Financial Markets, Not Private Information: The previously documented strong predictors are reflected in financial markets and not in the Fed’s private information.

2. Support for Wait-and-See: Controlling for financial conditions, recent real economic surprises negatively predict policy surprises—supporting the “wait-and-see” hypothesis over a more aggressive response to economic news (Bauer and Swanson, 2023b).

3. Financial Conditions Dominate: Financial conditions alone predict policy surprises as effectively as all other documented predictors combined.

Implications

• Challenges conventional identification of monetary policy shocks
• Provides insights into Fed decision-making processes
• Has implications for the measurement of monetary policy transmission
• Relevant for understanding market expectations and Fed communication

Citation

Chen, Zhengyang. “Demystifying Monetary Policy Surprises: Fed Response to Financial Conditions and Wait-and-See for New Economic Data.” Journal of Macroeconomics 87 (2026): 103736.

@article{chen2026demystifying,
  title={Demystifying Monetary Policy Surprises: Fed Response to Financial Conditions and Wait-and-See for New Economic Data},
  author={Chen, Zhengyang},
  journal={Journal of Macroeconomics},
  volume={87},
  pages={103736},
  year={2026},
  publisher={Elsevier},
  doi={10.1016/j.jmacro.2025.103736}
}