Bond market response to FOMC communication: Overreaction to Forward Guidance and Diagnostic Expectations

Since 2004, the Federal Reserve has released the minutes of Federal Open Market Committee (FOMC) meetings three weeks after each policy announcement, providing a natural setting to study how financial markets process sequential policy signals. This paper examines how the yield curve responds to both FOMC announcements and the subsequent release of meeting minutes. Using high-frequency identification, I extract monetary policy shocks and decompose them into target rate, forward guidance, and yield-curve “twist” components. I document a systematic overreaction of yields to the forward guidance component of announcements, followed by a partial reversal when the corresponding minutes are released. I interpret this pattern through a model of diagnostic expectations, in which investors initially overweight salient forward guidance signals and later revise their beliefs as additional context becomes available in the minutes. Working draft