Yield Curve and Financial Uncertainty: Evidence Based on US Data

Abstract

How does the yield curve respond to a jump in financial uncertainty? We address this question by conducting a local projections analysis with US monthly data, period: 1962- 2018. The state-of-the-art financial uncertainty measure proposed by Ludvigson, Ma, and Ng (2019) is found to predict movements in interest rates of the entire US yield curve. Both ends of the yield curve respond negatively and significantly. The response of the short end of the yield curve is found to be stronger than that of the long end, i.e., a financial uncertainty shock causes a temporary steepening of the yield curve. This result is consistent, among other interpretations, with medium-term expectations of a recovery in real activity after a financial uncertainty shock.

Keywords: financial uncertainty shocks, yield curve, local projections, inflation dynamics, output growth

JEL Classification: C22, E32, E52