Rational Expectations and the Market Impact of Economic Calendars

One of the most significant concepts in modern macroeconomics today is rational expectations or how people anticipate future events from all information available to them. This principle has one significant effect within the financial marketplace: prices respond not to the economic data itself but rather how it compares to what was predicted. This is why using calendars to track economic calendar reports plays an essential role in investor/trader decision-making.

Macroeconomic releases, such as inflation or employment data and central bank interest rate decisions, are among the most tracked types of events within financial markets. However, these announcements generally do not contain surprises in the strictest sense. While the announcement of a macroeconomic variable will yield a positive or negative surprise as of that date, prior to its impact, traders and analysts build expectations based on a consensus forecast derived from models, historic data and/or central bank communication. When the actual announcement occurs, it will create a market reaction based on the degree of difference between expected value (consensus forecast) vs realized value (the actual announced value).

This ongoing movement in the economy is influenced by economic activity, specifically by information and uncertainty. When people are said to have rational expectations regarding future outcomes, they take into account all currently available data and information about the things that impact their lives (like prices). Therefore the expectations of individuals regarding future outcomes can't have a significant impact on present prices because the price already reflect all currently known information.

Most importantly, the information economist use to describe and analyze an economy is expressed in what is referred to as an economic event or an economic calendar, which provides a guideline for understanding how and when an economic event will affect prices. The economic calendar lays out the macroeconomic signals in chronological order from a microeconomic perspective. It can give insight about how and when an economic event will be released, but the actual event will vary depending on the macroeconomic signals it references. Structuring the economic events around an economic calendar will lower the uncertainty associated with when an economic event will occur, however. Most importantly, using an economic calendar provides investors and market participants adequate time to prepare for any potential volatility in the market that may result from the macroeconomic events that occurred. So to clarify, economic calendars do not predict outcomes, but rather manage expectations and attention.

In many cases, actual surprises are much more influential on markets than absolute levels. The U.S. nonfarm payrolls report is one of the most significant labor market indicators released monthly. When actual payroll numbers differ from what was expected, empirical studies have shown that interest rate futures and equity indices can move significantly and immediately in response. Markedly similar to this phenomenon, adjustments to bond yields can occur immediately after the release of inflation data when actual Consumer Price Index numbers differ from expectations. An example of this can be found in the June 2022 higher-than-expected U.S. inflation report, which had an immediate impact on Treasury yields (i.e., they increased significantly) and caused equity markets to sell off because of an unexpected change in future monetary policy expectations.

Central banks also play a role in shaping market expectations through forward guidance in the form of future policy intentions. By communicating with market participants about anticipated future policy actions, central banks attempt to change market expectations beforehand. When market participants fully believe forward guidance from central banks, potential changes to a central bank's actual policy outcome will not have any immediate impact on markets (i.e., there will be no reaction). However, if there is miscommunication between forward guidance and subsequent actions, or if current economic conditions require a change to current forward guidance, the impact of this surprise is usually significant. The distinction between expected and unexpected policy action is central to the theory of rational expectations.

Price volatility implications go beyond the short run. Expectations will affect long-term investment choices, the cost of borrowing, and general economic behaviours. Stable, well-anchored expectations will also lead to more stable price movements and lower volatility in markets. When expectations are unstable or frequently updated, increased volatility occurs, and risk management becomes more difficult.

The data confirms these phenomena. Studies in financial economics have found that the majority of the intraday volatility of markets is clustered around macroeconomic announcement dates. Many of the days with high trading activity correspond to the announcement of macroeconomic indicators. This spike in trading activity indicates that the market has absorbed a significant amount of new information quickly.

In addition, the use of economic calendar tools allows market participants to coordinate their activities around the timing of key events in which expectations may change. Calendar tools provide predictable timing for pieces of information so that traders can focus on what is most important to their business: how the information will affect their view about the future, not the data itself.