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

55 Pages Posted: 19 Nov 2018 Last revised: 8 Feb 2019

See all articles by Farshid Abdi

Farshid Abdi

University of Saint Gallen, School of Finance; New York University, Stern School of Business

Botao Wu

New York University (NYU) - Leonard N. Stern School of Business

Date Written: August 2018

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

JEL Classification: G10, G12, E44, E52

Suggested Citation

Abdi, Farshid and Wu, Botao, Informed Corporate Credit Market before Monetary Policy Surprises: Explaining Pre-FOMC Stock Market Movements (August 2018). University of St.Gallen, School of Finance Research Paper No. 2018/28; NYU Stern School of Business. Available at SSRN: https://ssrn.com/abstract=3286135 or http://dx.doi.org/10.2139/ssrn.3286135

Farshid Abdi (Contact Author)

University of Saint Gallen, School of Finance ( email )

Unterer Graben 21
St.Gallen, CH-9000
Switzerland

New York University, Stern School of Business ( email )

44 West 4th Street
Suite 9-195D
New York, NY NY 10012
United States

Botao Wu

New York University (NYU) - Leonard N. Stern School of Business ( email )

44 W 4th Street
Suite 9-160
New York, NY 10012
United States

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