Unconventional monetary policy and the behavior of shorts

In November 2008, the Federal Reserve announced the first of a series of unconventional monetary policies, which would include asset purchases and forward guidance, to reduce long-term interest rates. Event studies and other analysis persuasively showed that these programs successfully reduced long yields and term premia and moved other asset prices, such as stock prices and foreign exchange rates, in desired directions. The nearly unprecedented size and success of these programs make this period one of the most important episodes in bond market history.

We investigate the behavior of shorts, widely regarded as among the most sophisticated investors, before and after these Federal Reserve monetary policy announcements. This research extends and complements previous research on the acuity of shorts as sophisticated investors to a new context.

We find that pre-announcement changes in the borrowed quantity (BQ) (i.e., a proxy for short interest) of agency and Treasury bonds portfolio systematically predicted changes in bond futures prices/yields over 42 unconventional monetary policy announcements during 2008-2013. That is, shorts tended to cover (expand) their short bond positions in the weeks prior to expansionary (contractionary) monetary announcements. Agency borrowed quantity has a somewhat greater predictive power than Treasury BQ. Changes in borrowed quantity also predict both term premia and expected short rates (swap rates). In adjusting their portfolios, shorts transact throughout the yield curve.

Using the methods of Cieslak-Schrimpf (2019) to construct the news content of monetary actions, we find that borrowed quantity most strongly predicts prices/yields best during events that released monetary or (especially) growth news.

Anticipating monetary policy surprises is a stringent test for the forecasting ability of shorts who must out predict marginal investors in very deep spot/futures bond markets, in which prices are determined almost entirely by public information. We believe that this is a unique and important result with respect to market efficiency and monetary policy expectations.

Shorts found the Fed announcements “credible” in the sense that expansionary (contractionary) announcements would lead them to cover (expand) their positions in the weeks following the event, but this pattern only existed when the Fed released growth news. Again, shorts made their post-event portfolio adjustments in bond positions across the yield curve.