The asymmetric and persistent effects of Fed policy on global bond yields

Summary

Focus

How monetary policy is transmitted through bond markets is a central question in macroeconomics and finance. The impact of monetary policy actions on the yield curve shapes domestic financial conditions, borrowing costs and savings returns, and thereby the effects on real activity. In the case of the United States, the centrality of its financial markets in the global financial system means that assessing the effects of US monetary policy on global bond markets is also key to gauging its overall impact.

We examine the impact of US monetary policy on US and international bond yields focusing on longer time horizons.

Contribution

In this paper, we conduct an in-depth examination of the impact of US monetary policy on US Treasury and global bond yields through 2022, assessing the behaviour of expected rates and term premiums, and differentiating between tightening and easing shocks. We investigate effects over long horizons and explore possible explanations for the observed patterns.

Findings

We document that US monetary policy shocks have highly persistent effects on longer-dated US Treasury yields. The effects are asymmetric for easing vs tightening shocks. There is also a clear break around the Great Financial Crisis (GFC). Prior to the GFC, tightening shocks used to have strong effects on yields, but easing shocks did not. Since the GFC, tightening shocks appear to lift yields for only a limited number of weeks and are followed by declines in yields later on. By contrast, easing lowers yields persistently. The pattern holds globally: the response of advanced economy and emerging market sovereign yields to US monetary shocks essentially mimics that observed for Treasury yields. Moreover, the slow and persistent reaction of flows to bond mutual funds is likely to account, at least partly, for the observed persistence. 

Abstract

We document that U.S. monetary policy shocks have highly persistent but asymmetric effects on U.S. Treasury and global bond yields, with a clear break around the Great Financial Crisis (GFC). Prior to the GFC, tightening shocks used to lead to a pronounced hump-shaped increase of Treasury yields across maturities. Yields used to respond little to easing shocks as term premiums would rise strongly, offsetting the associated decline of expected policy rates. Since the GFC, term premiums have been declining persistently following both tightening and easing shocks. As a result, post-GFC tightening shocks only have transitory positive effects on yields, which reverse later. The response of advanced-economy and emerging market sovereign yields essentially mimics the pattern observed for Treasury yields. Consistent with recent work by Kekre et al. (2022) we find that changes in the duration of primary dealer Treasury portfolios pre- and post-GFC are highly informative about the sign of the term premium response to policy shocks, but cannot explain the full picture. The observed puzzling persistence of returns is likely to stem at least in part from slow and persistent mutual fund flows following monetary policy surprises.

JEL Classification: F32, E43, E52, G12, G15

Keywords: spillovers, monetary policy, yield curve, capital flows