Oliver Ashtari Tafti, London School of Economics and Political Science
Rodrigo Guimaraes, Bank of England
Gabor Pinter, Bank for International Settlements
Jean-Charles Wijnandts, Bank of England
Abstract: The large reactions of long-term government bond yields to monetary policy shocks occur during periods of higher market liquidity, and there is very little reaction during periods of lower liquidity. This newly documented liquidity state-dependence persistently affects real yields, term premia as well as long-term mortgage rates. Conditioning on market liquidity yields stronger state-dependence than simply conditioning on macroeconomic indicators. Balance sheet constraints on both hedge funds and dealers contribute to the liquidity state-dependence. In addition to using publicly observable time-series data, we also exploit a unique, granular dataset which covers virtually all secondary-market trades of US Treasuries executed in London, and contains detailed information on each transaction including the identities of both counterparties. Consistent with our baseline results, we find that arbitrage activity is significantly higher when FOMC meetings occur during periods of higher market liquidity. Overall, our results underscore the importance of market functioning, and the financial health of key intermediaries that support it, for implementing stabilisation policies.
Abstract: We study supply-and-demand effects in the U.S. Treasury bill market by
comparing the returns on T-bills to the administered policy rate on the Federal Reserve’s
reverse repurchase (RRP) facility. In spite of the arguably more money-like properties
of an investment in RRP, we observe repeated episodes where one-month T-bill rates
fall well below expected RRP rates. This gap frequently exceeds 50 basis points in 2022,
before spiking to over 160 basis points during the initial period of uncertainty over the
debt ceiling in March and April of 2023. In an effort to understand this phenomenon, we
develop and test a simple model where the RRP-bill spread is policed by a group of
heterogeneous money funds, who differ in their elasticity of substitution between the
two assets. Our main finding is that when T-bills are scarce, and the spread is large, the
marginal money fund is more inelastic, as the more elastic funds have already exhausted
their holdings of T-bills. As a result, for a given shift in T-bill supply, the effect on rates
is an order of magnitude larger when T-bills are scarce, and when more money funds are
out of the market.
Discussant: Quentin Vandeweyer, University of Chicago
Abstract: Do investors interpret central bank target rate decisions as signals about the current state of the economy? We study this question using a short-term equity asset that entitles the owner to the near-term dividends of the aggregate stock market. We develop a stylized model of monetary policy and the equity term structure and derive tests of Fed information effects using the short-term asset announcement return. Consistent with the existence of information effects, we find that the short-term asset return in a 30-minute window around FOMC announcements loads positively on monetary policy surprises. Furthermore, the announcement return predicts near-term macroeconomic growth.
Discussant: Michael Bauer, Federal Reserve Bank of San Francisco
