Working Paper

Monetary policy and the corporate bond market: How important is the Fed information effect?

Abstract: Does expansionary monetary policy drive up prices of risky assets? Or, do investors interpret monetary policy easing as a signal that economic fundamentals are weaker than they previously believed, prompting riskier asset prices to fall? We test these competing hypotheses within the U.S. corporate bond market and find evidence strongly in favor of the second explanation—known as the "Fed information effect". Following an unanticipated monetary policy tightening (easing), returns on corporate bonds with higher credit risk outperform (underperform). We conclude that monetary policy surprises are predominantly interpreted by market participants as signaling information about the state of the economy.

Keywords: Monetary policy; Corporate bonds; Reaching for yield; Federal Reserve information;

JEL Classification: E40; E52; G12; G14;

https://doi.org/10.17016/FEDS.2021.010

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2021-02-16

Number: 2021-010