Are central bankers friends or foes of hedge funds and other seekers of alpha? In particular, what is the answer to this friend-or-foe question for the period since the global financial crisis a decade ago, where the central bankers with whom we are especially concerned are those at the US Federal Reserve?

These are the questions driving a new paper from three European scholars.

The scholars, led by Alexander Berglund of Stockholm University, conclude that the pronouncements of monetary policy coming from the Fed during the period from 2008 through 2016 have affected some hedge fund strategies more than others. Especially, these announcements have an impact on long/short equity and fixed-income arbitrage.

Berglund, et al., maintain, first, that hedge funds in general are characterized by a monthly abnormal alpha of -2.76 percent during periods dominated by monetary policy surprises. So the answer to the “friend or foe” question is pretty plainly: foe. But they may have become a foe only quite recently, by a process this study illuminates.

The Literature Review

In their review of the existing literature, these authors observe that authorities support the general notion that Fed surprises change asset prices. Thus, both during recessions and in tight credit market conditions stock prices react strongly to unexpected changes in the Fed funds target rate. It stands to reason that this ought to be important to the hedge funds whose strategy turns on the price moves of those stocks, the L/S equity funds.

Likewise, Edelberg and Marshall, in 1996, announced their finding that monetary policy shocks havesubstantial impact on one-month bond yields but that the response of longer term bonds is much weaker. One would reasonably expect, then, that such shocks would matter to hedge funds who depend on fixed-income arb in their search for alpha.

Much more recently, Goldman Sachs Global Investment Research has provided (2016) a breakdown of which Fed announcements were most surprising to the market. How can a notion such as “surprise” be given a quantitative metric? Goldman Sachs draws on 18 different market variables and the change in these variables on days of Fed policy announcements. The larger the moves in thesevariables on those days, the higher the “surprise” factor.