- Apr 01, 2025
- Strategy
Introduction
Pre-FOMC drift is a well-documented anomaly whereby stocks exhibit abnormally positive returns ahead of Federal Open Market Committee (FOMC) meetings, challenging traditional asset pricing models. In this blog post, I test this anomaly using data through December 2024 and find that it persists despite being published for more than a decade. The results confirm that this drift phenomenon holds true for different ETFs, with greater impact in high volatility environments. When applied to a triple-leveraged ETF, the strategy achieves 8-9% after-cost CAGR, a Sharpe ratio of approximately 0.6, and only 5% trading time.
Background
The impact of FOMC rate decisions on financial markets has been widely documented, especially their impact on stock and bond returns and volatility dynamics. While stock market reactions to unexpected rate changes are well known, a growing body of research highlights systematic return patterns in the days leading up to FOMC announcements.
A seminal study by Lucca and Moench (2015) documents the phenomenon of pre-FOMC announcement drift, a persistent pattern whereby the S&P 500 exhibits significant positive excess returns in the 24 hours prior to scheduled FOMC meetings. These pre-FOMC returns account for more than half of the excess total equity market returns realized over the year since 1994, a striking finding given that similar patterns have not been observed in bonds, currencies, or commodities. Notably, this drift does not reverse after the announcement, suggesting that it is not driven by immediate information releases but rather by investors gradually positioning ahead of monetary policy decisions.
The pre-FOMC drift phenomenon may in part reflect compensation for bearing macroeconomic risk. Savor and Wilson (2013) show that expected returns on scheduled macroeconomic announcement days (including FOMC meetings) are significantly higher than on other days, suggesting that investors demand a risk premium for holding assets amid uncertainty about policy events. However, because this drift occurs before rather than after the announcement, it is distinct from traditional macroeconomic risk premia. This raises questions about whether the pattern is driven by information asymmetry, risk-based factors, or investor behavioral biases.
Subsequent research has examined the robustness and evolution of the pre-FOMC effect. Cieslak, Morse, and Vissing-Jorgensen (2019) extend the analysis, showing that the FOMC indirectly affects stock returns across the policy cycle as investors adjust their risk exposure in response to the Fed's actions. Recent evidence suggests that pre-FOMC drift is now concentrated around meetings that include press conferences, while meetings without press conferences no longer exhibit the same pattern (Lucca & Moench, 2018). This shift implies that investors are increasingly focusing on the communication component of monetary policy, rather than just interest rate changes.
Another way to understand FOMC drift is the risk premium associated with FOMC meetings. Liu, Tang, and Zhou (2021) estimate the FOMC risk premium using option prices and find that it varies widely over time, averaging 45 basis points but ranging from 1 to 326 basis points between 1996 and 2019. Their study highlights that the premium is higher during periods of low consumption growth, low GDP growth, low inflation, or elevated market volatility (VIX). This suggests that the compensation that investors demand for bearing FOMC-related uncertainty is dynamic and correlated with broader economic conditions.
Overall, the literature provides compelling evidence of positive price drift around FOMC meetings, generating abnormal returns in the days and hours before the announcement. I illustrate this effect below using 1-minute data on SPY from January 2014 to December 2024, measuring price drift around scheduled FOMC meetings, all of which last two days. The figure below plots the cumulative average returns over these periods.
It is clear that prices drift upward starting from the close of the day before the meeting and continue to rise until the end of the last day of the meeting. The drift peaks and becomes more volatile in the second half of the second day, coinciding with the timing of the FOMC policy decision and the subsequent press conference by the Fed Chairman.
Strategy
Let us now consider a trading strategy designed to exploit this pattern.
Data
I test the strategy using SPY close data from its inception in January 1993 to December 2024 obtained from EODHD. I also report results for QQQ and the 3x leveraged ETFs SPXL and TQQQ. The analysis includes only scheduled Fed meetings, with the first few years in the sample consisting mainly of one-day meetings, while two-day meetings become more common in later years.
For excess returns and Sharpe ratio calculations, I use the 3-month Treasury bill rate (DTB3) from FRED (Federal Reserve Bank of St. Louis).
Testing
To evaluate the effectiveness of this model, I constructed a trading strategy that enters a long position at the close of the day before the FOMC meeting and exits it at the close of the last meeting day. For a two-day meeting, this means entering a long position the day before the first meeting day.
The strategy earns the risk-free rate in cash, and I report results with and without transaction costs, assuming 5 basis points each way.
SPY
The strategy has a CAGR of about 4% and a Sharpe ratio of 0.5-0.6. Its low volatility is primarily due to the fact that it trades only on 5% of trading days, as the Fed typically holds eight meetings per year. Notably, the strategy has continued to perform well even after the above study, although it experienced a period of plateauing between 2016 and 2019 before gaining momentum again in recent years.
Testing whether the strategy returns differ from returns on non-FOMC days, I find that the difference is highly statistically significant, further supporting the uniqueness of FOMC price drifts.
To test whether the strategy can generate higher returns, I apply it to QQQ and 3x leveraged ETFs TQQQ and SPXL, which amplify market volatility.
SPXL
Although the strategy trades on only 5% of the days, it generates 8-9% CAGR for the triple leveraged ETF. The after-cost Sharpe ratio is about 0.6, the maximum drawdown is about 18%, and the drawdown-to-volatility ratio is 1.3, which is attractive compared to many other strategies.
The Effect of Uncertainty
Prior research finds a positive relationship between FOMC price drift and market uncertainty, indicating that drift is stronger during periods of high uncertainty. This supports the uncertainty resolution hypothesis, which holds that investors demand a premium for taking policy-related risks before FOMC meetings, and returns adjust as uncertainty dissipates.
To test this, I examine the relationship between the VIX level at trade entry and the cumulative strategy returns during the FOMC meeting. I then divide the VIX level into quartiles and plot the average strategy return within each bin.
The pattern is significantly stronger during periods of higher market volatility and closer to zero in low volatility environments. This suggests that the strategy not only exploits pre-FOMC price drift but also provides diversification benefits, especially during periods of heightened market volatility when traditional equity strategies often struggle.
Conclusion
I find that the pre-FOMC price drift first documented by Lucca and Moench (2015) remains persistent. The results hold across different ETFs, including SPY, QQQ, and leveraged ETFs such as TQQQ and SPXL. Notably, the strategy continues to generate positive risk-adjusted returns in recent years, despite the fact that the effect was published more than a decade ago. One of the most striking observations is the relationship between the strength of the drift and market uncertainty, as measured by the VIX. Drift and strategy returns are significantly stronger during periods of higher volatility, supporting the uncertainty resolution hypothesis. As the Fed increasingly relies on forward guidance and communication, investors should recognize that FOMC press conferences now play a key role in driving market moves.
The strategy presents a repeatable pattern that may be attractive to investors, especially those using leveraged ETFs, and has a CAGR of approximately 9% despite trading only 5% of the time. Its strong performance in high volatility environments suggests it could provide diversification benefits to equity investors. This approach could be expanded to other macroeconomic announcements and information-driven events beyond FOMC meetings, potentially increasing trading frequency and return opportunities in both U.S. and international markets.