The long bond yield ‘conundrum’

What´s the ‘meaning’ of the rise in the long bond yield after May 1st? This is being widely discussed. Evan Soltas did a post a few days ago which was picked up by Scott Sumner.

According to Evan:

There are two theories of why interest rates are rising. In the first, they are rising because of an improved economic outlook, which leads investors to anticipate a swifter exit for monetary policy. In the second, they are rising because of a change in investor expectations of the monetary exit, independent of economic conditions.

Fortunately, statistics has a way of answering these questions: correlation. (Or at least, helping us answer these questions.) I downloaded the daily time series data of the 10-year Treasury note yield and the S&P 500 stock index from June 2008 through the present. If on days that rates are rising, the stock index also rises, then we can assume that both are driven by changes in the economic outlook. If on days that rates are rising, the stock index is falling, then the “economic outlook” story doesn’t hold up — and a “monetary policy” story fits.

I calculated the 90-day correlation coefficient of their daily percentage changes. I find that it has been plummeting since May, which is when interest rates began to jump. See how it’s falling off a cliff at the right end of the chart? That means the first story (“happy days are here again”) is wrong, and the second story (“the Fed is tightening”) is right.


If the Fed doesn’t intend for all of its talk since the start of May to be perceived as pushing forward the schedule for monetary tightening, independent of the economic recovery, it needs to start clarifying its intentions. Now.

And Scott says:

It seems plausible that part of the rise in rates since May has been driven by positive economic news, but I agree with Evan that the recent sharp increases in interest rates mostly reflect expectations of tighter Fed policy.  And I think he’s provided the most persuasive evidence in the blogosphere for that view.

I redid Evan´s chart but only show it for the more recent period and I add some ‘bells & whistles that maybe help understand the argument.

The first chart shows that the stock market continued to rise following the “threshold” contingency the FOMC put out in its December 12 meeting. At that moment the correlation coefficient went up and stayed up all the way to the release of the Minutes from the May 1st FOMC Meeting on May 22nd where the ‘taper talk’ showed up.

The statement from the May 1st meeting apparently gave the impression that the Fed was ‘positive’ on the outlook. Stock and bond yields went up and so did the dollar against major currencies .

But on May 22nd the ‘world changed’, i.e. the view became that tightening would happen independently of economic conditions. The correlation tanked. Bonds continued to rise but stocks and the dollar fell. And this was reinforced in the June 19 FOMC meeting statement and Bernanke´s press conference. This time around, however, the dollar rose maybe a reflection of heightened uncertainty.

Maybe China has lately been a factor but I think there´s no way to go around the fact that the Fed has indeed tightened.



Correlation_3Update: 5 year inflation expectations dropped steeply below 2% after May 21 and again after last week´s FOMC meeting and PC:



3 thoughts on “The long bond yield ‘conundrum’

  1. On May 31 Krugman did a simple chart analysis of the rise in long rates and concluded it meant “Stronger recovery”:

    The key thing was the dollar and the stock market were both up at that time.

    But with the benefit of hindsight we see that the S&P 500 had peaked on May 21 and whereas it was only down 0.9% on May 30, it is now down over 5.8%. Thus Krugman’s nifty little chart analysis is now screaming “Tougher Fed”.

    Even if China is a factor, China is not responsible for how the Fed reacts, or fails to react, to changing economic conditions. If monetary policy is getting rapidly tighter the Fed probably should do something now rather than wait until later.

    P.S. This would be a lot simpler with an NGDP futures market.
    P.P.S. Given David Glasner’s past observations on inflation expectations and the stock market I wonder what he will say when he gets around to it.

  2. Pingback: The long bond yield ‘conundrum’ | Fifth Estate

  3. Here’s what I think:
    The faster movement in long term rates might simply be, if taking Friedman’s view of interest rates to heart, a reflection that because the Fed didn’t step on the brake completely and provided a little more certainty, policy will be a bit less tight once the “taper” is complete. The market was pricing in more certainty over the ongoing policy action – as if perhaps the majority of the hand-wringing about when, where, how much was settled. My guess is that the more certainty the Fed provides the more bang we can get out what they’re already doing.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.