Using variation in the stock market and the Treasury yield curve, we identify shocks to investors’ expectations of monetary policy and economic growth as well as pure risk-premium shocks. We trace out the effects of those shocks day-by-day, and explain the puzzling fact that stocks but not bonds earn high average returns on Federal Open Market Committee (FOMC) announcement days and over the FOMC cycle. About 70% of the average positive stock returns earned over the FOMC cycle stems from the declining premiums, with the remaining 25% explained by accommodating monetary news, and only a small fraction by positive growth news. While Treasury bonds respond strongly to the same shocks, the signs of their responses are ambiguous as bonds hedge the cash-flow risk in stocks. Reductions in the bonds' insurance premium nearly completely offset any gains, making overall bond returns economically small and statistically insignificant. We also document that since the mid-1980s, monetary news accounts for about 40% of the variation in the two-year yield, but less than 10% and 20% of the variation in the ten-year yield and the aggregate stock market, respectively. The results suggest that the Fed has a significant effect on long-duration assets through its ability to affect the risk premiums.

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