Equity Market Investing: Macro Matters

Abstract

The connection between central bank policy and fixed-income markets is clear, but the Fed’s actions and words also find traction outside of bonds and bills. Equity markets, just like fixed income, also react to Fed communications. As Marcel Fratzscher, the former head of policy analysis at the European Central Bank, and Michael Ehrmann, the head of economic and financial research at Bank of Canada, have asserted, “Central bank communication is a statistically and economically important driver of financial markets” (Ehrmann and Fratzscher 2007). Economists and financial professionals have observed the budding ties between central bank dispatches and the equity markets in recent years, and our work integrating textual analysis with market reaction sheds additional light on this trend. Diving into the world of equities, this chapter explains the fundamentals underpinning equity markets. After covering the essentials, it then highlights the deep connections that have developed between central banks and equity movements—and the reasons behind this growing relationship. Finally, this chapter investigates the application of our central banking data to this space, demonstrating how our methodology could provide deeper insight into the ebb and flow of the modern equity markets.