Working Paper: CEPR ID: DP16629
Authors: Carlo A. Favero; Andrea Tamoni; Alessandro Melone
Abstract: We study drift and cyclical components in U.S. Treasury bonds. We find that bond yields are drifting because they reflect the drift in monetary policy rates. Empirically, modeling the monetary policy drift using demographics and productivity trends, plus long-term inflation expectations, leads to cyclical deviations of bond prices from their drift that predict bond returns in- and out-of-sample. These bond cycles can originate from term premia or temporary deviations from rational expectations in a behavioral framework. Through the lens of our model, we detect a significant role of the latter in determining the cyclical properties of yields with short maturities.
Keywords: Monetary Policy Rule; Secular Trends; Term Structure; Diagnostic Expectations; Bond Return Predictability
JEL Codes: E43; E52; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Stationary deviations of bond prices from their drift (G19) | Predict excess bond returns (G12) |
| Drifting monetary policy rates (E43) | Drifting bond yields (E43) |
| Demographic trends, productivity growth, long-term inflation expectations (J11) | Bond yield fluctuations (E43) |
| Bond yield fluctuations (E43) | Cyclical deviations in bond prices (E32) |
| Cyclical deviations in bond prices (E32) | Predict bond returns (G17) |
| Diagnostic expectations (C52) | Fluctuations in yield cycles for bonds with shorter maturities (E32) |