Announcement Effect Definition (2024)

What Is the Announcement Effect?

The announcement effect broadly refers to the impact that any type of news or public announcement—especially when issued bygovernment 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. This potential for negative outcomes is known as headline risk.

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. The announcement effect may also go by the terms "headline effect" or "media effect."

Understanding the Announcement Effect

The announcement effect assumes that the behavior of systems (such asfinancial markets) or people (such asindividual 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 splitor change in dividend policy.

For example, if a company announces an acquisition, then its stock price may rise. Alternatively, if the government says that the 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-bustresponses. Moreover, central bank announcements can induce rather than reduce volatility.

The Announcement Effect and the Federal ReserveSystem

An announcement from the Federal Reserve ("the Fed") 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. Thusbegan 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 thatbecause 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.

Ingeneral, 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 classesor moving in and out of the market altogether.

Although investment professionals oftendisagree on the finer points of technical theory, they do agreethat the stock market is driven by news. Researchers have suggested that bad news has a larger impact on markets than good news, and that good news does not lift the market as much as bad news depresses it. Also, bad news during a bear markethas a bigger negative impact than bad news during a bull market, and negative surprises often have a greater impact than positive surprises.

Whether negative or positive, the announcement effect always carries the potential to cause drastic changes in stockprices 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—acomment that broke with thelong tradition that United States presidents do not interfere with the business of the Fed.

Minimizing the Effect of Announcements

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 allowthe 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 itmight make before it actually makes them, so that the market can adjustsmoothly to the new information.