Bond supply, yield drifts and liquidity provision before macroeconomic announcements

Summary

Focus

Two of the most important drivers of nominal interest rates are the arrival of macroeconomic news and changes in the supply of government bonds. These two factors have become more and more intertwined as bond issuances have increasingly occurred near scheduled macroeconomic announcements. Yet, how the interaction between these two forces affects investor behaviour, bond market liquidity and ultimately interest rates is not well understood. We fill this gap in the literature.

Contribution

We use aggregate and granular transaction-level data to empirically study the interaction between macroeconomic announcements and government bond supply as well as the effect of this interaction on interest rates. By analysing transaction-level data, we provide new insights into the behaviour of financial intermediaries and the composition of liquidity providers in the bond market. We also present a simple model to illustrate the mechanics of secondary market trading following bond issuance and before news events.

Findings

We find that UK government bond yields tend to rise in the two days before macroeconomic announcements, a phenomenon we call the "pre-news yield drift". This effect is concentrated in periods when new government bonds are issued. This yield drift is primarily driven by an increase in term premia. We also find that financial intermediaries, such as primary dealers, play a crucial role in this process, as they tend to avoid accumulating inventory before news events. Additionally, the composition of liquidity providers changes, with hedge funds more active outside pre-news windows, and more passive investors, such as foreign central banks and pension funds, stepping in during pre-news windows.

Abstract

UK government bond yields tend to rise in a two-day window before scheduled macroeconomic announcements such as labour market data releases and monetary policy news. This effect, particularly pronounced during UK bond issuances, is linked to higher term premia. Financial intermediary constraints play a role as dealers avoid accumulating inventory in pre-news windows with issuances. The composition of liquidity providers also shifts: hedge funds buy a larger share of the bond issuance outside pre-news windows, but more passive investors, such as foreign central banks and pension funds, provide liquidity in pre-news windows. We outline a simple model to rationalise these findings.

JEL classification: G11, G12, G14, D83, D84

Keywords: macroeconomic announcements, interest rate drift, bond supply, liquidity provision