Monetary Policy and Bond Prices with Drifting Equilibrium Rates
49 Pages Posted: 15 Oct 2020 Last revised: 30 Apr 2021
Date Written: October 4, 2020
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 Classification: E43, E52, G12
Suggested Citation: Suggested Citation