Monetary Uncertainty as a Determinant of the Response of Stock Market to Macroeconomic News

Abstract: This paper examines the effect of macroeconomic news announcements (MNA) on the stock market. Stocks exhibit a strong positive response to major MNA: 1 standard deviation of MNA surprise causes 11-25 bps higher returns. This response is highly time-varying and is weaker during periods of high monetary uncertainty. I decompose this response into cash flow and risk-free rate channels. 1 standard deviation of good MNA surprise leads to plus 30 bps returns from the cash flow channel and minus 23 bps per 1\% of monetary uncertainty from the risk-free rate channel. Risk-free rate channel is time-varying and is stronger when monetary uncertainty is high. High levels of monetary uncertainty mask the strong positive response of stocks to MNA, which explains why past research failed to detect this relation.