Abstract
I study the flow of macroeconomic information to the corporate bond market and its impact on transaction prices across FOMC cycles. I estimate a regime switching model and find that bond returns are linked to two distinct regimes. The states coincide with monetary policy news releases. I link returns with liquidity through a study of more than 60 million trades which demonstrates that there is a large gap in effective spreads (difference in bid and ask transaction prices) between the two regimes. The most significant effect is exhibited by retail size transactions. I attribute this difference to considerable uncertainty ahead of macro announcements during the cycles, which in turn leads to changes in risk aversion and inventory capacity of financial intermediaries.
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