Monetary Policy and Bond Prices with Drifting Equilibrium Rates

Carlo Favero, Andrea Tamoni and Alessandro Melone

No 16629, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: 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 (search for similar items in EconPapers)
JEL-codes: E43 E52 G12 (search for similar items in EconPapers)
Date: 2021-10
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