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Informed Corporate Credit Market Before Monetary Policy Surprises: Explaining Pre-FOMC Stock Market Movements

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  • Farshid Abdi
  • Botao Wu

Abstract

We show that U.S. corporate bond market movements during the days preceding FOMC announcements can predict monetary policy surprises, as well as the pre-FOMC stock market movements. Starting several days before an expansionary (contractionary) surprise in FOMC decisions, corporate bond prices surge (decline) and yield spreads decline (surge). The pattern is statistically and economically significant. Moreover, corporate bond customers buy (sell) more often from dealers before expansionary (contractionary) surprises, suggesting that in aggregate they have more accurate information about the outcome of FOMC announcements. A portfolio that mimics customer trades is profitable with a Sharpe ratio of 0.64 and is profitable before both contractionary and expansionary surprises. Furthermore, consistent with the informativeness of corporate bond transactions, we show that lagged corporate bond customer-dealer trade imbalances can predict pre-FOMC stock market movements and explain pre-FOMC drift. Corporate bond yield changes "Granger-cause" stock pre-FOMC movements, and a 1% surge in the constructed TRACE bond yield during a 2 p.m.-to-2 p.m. period ending one day before an FOMC announcement, predicts a 5.8% decline in the S&P 500 index for the 2 p.m.-to-2 p.m. period ending on the FOMC meeting day. This bond-to-stock granger causality does not exist for non-pre-FOMC periods and is stronger for the companies with higher probability of default.

Suggested Citation

  • Farshid Abdi & Botao Wu, 2018. "Informed Corporate Credit Market Before Monetary Policy Surprises: Explaining Pre-FOMC Stock Market Movements," Working Papers on Finance 1828, University of St. Gallen, School of Finance.
    • Handle: RePEc:usg:sfwpfi:2018:28
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    Cited by:

    1. Seung Kwak, 2022. "How Does Monetary Policy Affect Prices of Corporate Loans?," Finance and Economics Discussion Series 2022-008, Board of Governors of the Federal Reserve System (U.S.).
    2. Czech, Robert & Pintér, Gábor, 2020. "Informed trading and the dynamics of client-dealer connections in corporate bond markets," Bank of England working papers 895, Bank of England, revised 20 Jan 2022.
    3. Chao Ying, 2020. "The Pre-FOMC Announcement Drift and Private Information: Kyle Meets Macro-Finance," 2020 Papers pyi149, Job Market Papers.

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    More about this item

    Keywords

    Pre-FOMC Announcement Drift; Corporate Bond; Credit Risk; Enhanced TRACE; TAQ;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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