Economic news carries the potential to cause shifts in asset prices, and, in particular, changes in market expectations about future economic performance. Basic economic thinking would suggest that a surprise in, say, the inflation rate or GDP growth rate should lead to a rise in interest rates, while news about central bank policies should prompt a change in exchange-rate and bond yields. But in practice, the relationship between news and prices is complex.
A major issue is that survey-based measures of expectations may contain errors. In addition, survey data is collected with leads ranging from a few days to a week or more in advance of the release of a given indicator. This lag introduces uncertainty about the true state of market expectations that could be reflected in the expected response to a given piece of news. As a result, the standard approach to measuring news (i.e., estimating the effect of an indicator announcement by regressions with its forecasts as regressors) tends to produce overly low estimates of asset price responses.
This article develops a methodology to estimate the impact of economic news that does not rely on survey-based measurements of expected responses and that is cleaned of measurement errors. Using this new methodology, the authors find that the immediate effects of some economic indicators on interest-rate and exchange-rate markets are economically significant and measurably persistent through the rest of the business day. They also confirm that news of stronger-than-expected growth and inflation generally prompts a rise in bond yields and exchange rates, with stock prices reacting most weakly and erratically.
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