Working Paper: NBER ID: w25127
Authors: Jordan Brooks; Michael Katz; Hanno Lustig
Abstract: The sensitivity of long-term rates to short-term rates represents a puzzle for standard macro-finance models. Post-FOMC announcement drift in Treasury markets after Federal Funds target changes contributes to the excess sensitivity of long rates. Mutual fund investors respond to the salience of Federal Funds target rate increases by selling short and intermediate duration bond funds, thus gradually increasing the effective supply to be absorbed by arbitrageurs. The gradual increase in supply generates post-announcement drift in longer Treasury yields, which spills over to other bond markets. Our findings shed new light on the causes of time-series-momentum in bond markets. A model in which mutual fund investors slowly adjust their extrapolative expectations of future short rates after a target change can qualitatively match the dynamics of yields and fund flows.
Keywords: bond markets; FOMC announcements; mutual funds; interest rates
JEL Codes: E43; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy surprises (E39) | treasury yields (E43) |
| FOMC announcements (E52) | treasury yields (E43) |
| FOMC announcements (E52) | mutual fund flows (G23) |
| mutual fund flows (G23) | treasury yields (E43) |
| FOMC raises federal funds target rate (E52) | mutual fund investors sell short and intermediate duration bond funds (G23) |
| mutual fund investors sell short and intermediate duration bond funds (G23) | effective supply of bonds (G12) |
| effective supply of bonds (G12) | long-term yields (E43) |
| FOMC announcements (E52) | overreaction in long-term bond yields (E43) |
| FOMC announcements (E52) | return impact on average fund (G23) |