Bond supply, price drifts and liquidity provision before central bank announcements

We document that UK government bond yields systematically rise in a two-day window before Monetary Policy Committee (MPC) meetings, which we refer to as pre-MPC windows. The effect concentrates on pre-MPC windows that coincide with new issuance of government bonds. Decomposing the effect into an expected short-rate and a risk premium component, we find that the majority of the yield drift is attributed to increases in risk premia. These effects are present in the US as well. Using UK transaction-level data and analysing trading activity after primary issuances, we find that the dealer sector sells significantly more to the client sector during pre-MPC windows, consistent with dealers’ limited risk-bearing capacity. Importantly, we find significant changes in the composition of liquidity providers: hedge funds buy a large share of the issue outside pre-MPC windows, but they shy away from liquidity provision in pre-MPC windows, being replaced by less speculative investors such as foreign government entities and pension funds. We propose a theoretical model to rationalise the change in the composition of liquidity providers before high-informational events, which can also explain the price drift observed in the data.