Expectations and Risk Premia at 8 : 30am: Deciphering the Responses of Bond Yields to Macroeconomic Announcements

What explains the sharp movements of the yield curve in response to major U.S. macroeconomic announcements? To answer this question, we estimate an arbitrage-free dynamic term structure model with macroeconomic fundamentals as risk factors. We assume that the yield curve reacts to announcements primarily because of the information these contain about the fundamentals of output,inflation and the Fed's inflation target. We model the updating process by linking the factor shocks to announcement surprises. Fitting this process to data on yield curve movements in 20-minute event windows, we find that most major announcements, especially those concerning the labor market, are informative largely about the output gap rather than inflation. The resulting changes in short-rate expectations account for the bulk of observed yield movements. But adjustments in risk premia are also sizable. In partly offsetting the effects of short-rate expectations, these adjustments help to account for the well-known hump-shaped pattern of yield reactions across maturities