Treasury Return Predictability and Investor Sentiment

Abstract

We document that the Treasury market investor sentiment (TSENT) of institutional investors is a powerful predictor of bond risk premia. Specifically, TSENT positively predicts Treasury bond excess returns in- and out-of-sample. The forecasting gains of TSENT are incremental to that in conventional bond return predictors: Fama-Bliss forward spreads (FB), the Cochrane and Piazzesi (2005) forward rate factor (CP), and the Ludvigson and Ng (2009) macro factor (LN), as well as equity market sentiment proxies such as the investor sentiment index of Baker and Wurgler (2006) and the PLS sentiment index of Huang, Jiang, Tu, and Zhou (2015). Asset allocation analysis indicates the forecasting power of TSENT is economically valuable to investors. Finally, we show that the time-series bond risk premia predictability associated with TSENT relates to its predictive power for macroeconomic performance, such as payroll employment, unemployment rate, and industrial production.

Keywords: Treasury; investor sentiment; return predictability; economic value

JEL Classification: G11; G12; G17