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The US Stock Market Leads the Federal Funds Rate and Treasury Bond Yields


Kun Guo


Chinese Academy of Sciences (CAS)

Wei-Xing Zhou


East China University of Science and Technology - School of Business

Si-Wei Cheng


Chinese Academy of Sciences (CAS)

Didier Sornette


Swiss Finance Institute; ETH Zurich

February 11, 2011

Swiss Finance Institute Research Paper No. 11-05

Abstract:     
Using a recently introduced method to quantify the time varying lead-lag dependencies between pairs of economic time series (the thermal optimal path method), we test two fundamental tenets of the theory of fixed income: (i) the stock market variations and the yield changes should be anticorrelated; (ii) the change in central bank rates, as a proxy of the monetary policy of the central bank, should be a predictor of the future stock market direction. Using both monthly and weekly data, we found very similar lead-lag dependence between the S&P500 stock market index and the yields of bonds inside two groups: bond yields of short-term maturities (Federal funds rate (FFR), 3M, 6M, 1Y, 2Y, and 3Y) and bond yields of long-term maturities (5Y, 7Y, 10Y, and 20Y). In all cases, we observe the opposite of (i) and (ii). First, the stock market and yields move in the same direction. Second, the stock market leads the yields, including and especially the FFR. Moreover, we find that the short-term yields in the first group lead the long-term yields in the second group before the financial crisis that started mid-2007 and the inverse relationship holds afterwards. These results suggest that the Federal Reserve is increasingly mindful of the stock market behavior, seen at key to the recovery and health of the economy. Long-term investors seem also to have been more reactive and mindful of the signals provided by the financial stock markets than the Federal Reserve itself after the start of the financial crisis. The lead of the S&P500 stock market index over the bond yields of all maturities is confirmed by the traditional lagged cross-correlation analysis.

Number of Pages in PDF File: 15

Keywords: monetary policy, federal funds rate, yield curves, stock markets, causality, lead-lag, dependence

JEL Classification: C14, C53, E44, E47, E58, G17

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Date posted: February 17, 2011  

Suggested Citation

Guo, Kun and Zhou, Wei-Xing and Cheng, Si-Wei and Sornette, Didier, The US Stock Market Leads the Federal Funds Rate and Treasury Bond Yields (February 11, 2011). Swiss Finance Institute Research Paper No. 11-05. Available at SSRN: http://ssrn.com/abstract=1762788 or http://dx.doi.org/10.2139/ssrn.1762788

Contact Information

Kun Guo
Chinese Academy of Sciences (CAS) ( email )
Building 917
Datun Road
Anwai, Beijing, 100101
China
Wei-Xing Zhou
East China University of Science and Technology - School of Business ( email )
130 Meilong Road
Shanghai, 200237
China
Si-Wei Cheng
Chinese Academy of Sciences (CAS) ( email )
Building 917
Datun Road
Anwai, Beijing, 100101
China
Didier Sornette (Contact Author)
Swiss Finance Institute ( email )
c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland
ETH Zurich ( email )
Department of Management, Technology and Economics
Scheuchzerstrasse 7
8092 Zurich
Switzerland
41446328917 (Phone)
41446321914 (Fax)
HOME PAGE: http://www.er.ethz.ch/
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