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

Farshid Abdi and Botao Wu

No 1828, Working Papers on Finance from University of St. Gallen, School of Finance

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.

Keywords: Pre-FOMC Announcement Drift; Corporate Bond; Credit Risk; Enhanced TRACE; TAQ (search for similar items in EconPapers)
JEL-codes: E44 E52 G10 G12 (search for similar items in EconPapers)
Pages: 55 pages
Date: 2018-08
New Economics Papers: this item is included in nep-mac, nep-mon and nep-rmg
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:usg:sfwpfi:2018:28

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