Do FOMC Actions Speak Loudly? Evidence from Corporate Bond Credit Spreads*

Abstract

We find that Federal Open Market Committee (FOMC) actions (especially rate cuts) narrowed corporate credit spreads during the pre-crisis period of 2002-2007. During the 2008 crisis period, we find that both conventional cuts and quantitative easing decreased spreads. But FOMC inactions caused significant widening of spreads. The effects are especially large for speculative-grade and short-maturity bonds. Overall, the policy uncertainty during the crisis and macroeconomic theories during the pre-crisis period help to explain why FOMC announcements impacted credit spreads. The Fed's actions targeted at promoting growth and/or providing systemic liquidity were especially noted by the corporate bond market.

Credit Risk and the Transmission of Interest Rate Shocks

“…Not all firms respond to monetary policy in the same manner. Consistent with recent cross-sectional evidence (e.g., Javadi, Nejadmalayeri, and Krehbiel (2017), Guo, Kontonikas, and Maio (2020), and Smolyansky and Suarez (2020)), we find that firm-level risk is an important driver of the response to monetary policy shocks. Riskier firms, that is firms with higher ex-ante CDS spread levels, display a stronger sensitivity to monetary policy shocks than less risky firms do.…”

Monetary Policy and Corporate Bond Returns

“…In line with this theory's prediction, apart from Gertler and Karadi (2015), a number of other studies demonstrate empirically that the bond credit spread increases when monetary policy tightens (Avramov et al, 2007;Chun et al, 2014;Cenesizoglu and Essid, 2012). In a recent study, Javadi et al (2017) find that credit spreads mostly respond to expansionary policy actions (by narrowing), while tightening only affects spreads when default and inflation risks are ex ante high.…”

“…The literature on corporate bonds is overall less voluminous, and even thinner with regards to the impact of monetary policy actions. Previous studies tend to focus on two issues-the predictability of corporate bond returns (Fama and French, 1989;Jensen et al, 1996;Baker et al, 2003;Greenwood and Hanson, 2013) and the factors that determine the credit spread (Collin-Dufresne et al, 2001;Elton et al, 2001;Driessen, 2005;Avramov et al, 2007;Gertler and Karadi, 2015;Javadi et al, 2017;Nozawa, 2017). With the exception of a small number of studies that we discuss later in this section, the role of monetary policy actions in general, and policy rate shocks in particular, has been under-explored in the case of corporate bonds.…”

The Short-Run Effect of Monetary Policy Shocks on Credit Risk: An Analysis of the Euro Area

“…3 While the literature for the Euro Area is quite thin, Wright (2012), Beckworth, Moon, and Toles (2010), and Cenesizoglu and Essid (2012) show for the US that corporate bond yield spreads react significantly to monetary policy shocks. Javadi, Nejadmalayeri, and Krehbiel (2017) provide evidence that the effect of the systematic component of monetary policy may lead to higher market uncertainty in crisis times and to an adverse response of corporate credit spreads.…”