Fed decisions may influence long-term bond yields

In theory, the tactical, meeting-to-meeting interest rate decisions made by the Federal Reserve shouldn't much matter for borrowing costs over decades to come. The theory, however, appears to be wrong.

The big picture: Research out this week shows that the post-COVID surge in long-term bond yields has been uncannily concentrated around either major Fed communications or the release of the jobs report that in turn affects near-term Fed decisions.

• That is in tension with the notion that longer-term bond yields are set in the open market based on investors' expectations of long-term economic growth, inflation, supply and demand for capital, and credit risk.

By the numbers: Of the 4 percentage point run-up in long-term Treasury yields between August 2020 and the start of this month, 90.5% took place in a three-day window around the monthly jobs report or major Fed speeches.

• Those windows accounted for only 24% of trading days.
• That's according to new research from Paul Beaudry, Paolo Cavallino and Tim Willems published earlier this week on VoxEU.

Of note: This finding aligns with earlier research from Harvard economist Sebastian Hillenbrand, which found that the three-decade secular decline in long-term yields occurred almost entirely in a tight window around Fed announcements.

The intrigue: The last 24 hours fit the pattern. Wednesday's surge in long-term bond yields was driven by events that would not formally count in the study, but that align with the idea that the short-term monetary policy outlook is the major driver of long-term rates.

• Flash PMI numbers — an early, volatile indicator of this month's economic growth — accelerated, and Fed governor Michael Barr gave a speech suggesting that he sees more rate increases ahead.
• Those two seemingly minor developments pushed the 30-year Treasury yield up from 5.3% to 5.41%, a 23-year high.

Between the lines: One possibility is that there's something about Fed pivot points that triggers investors to re-evaluate longer-term factors affecting the cost of money.

• Maybe it's easier for investors to incorporate things like the deficit and AI investment outlook into their long-term thinking when the day's news brings a near-term Fed response.
• Another possibility is that looking at long-term rates through a fundamental supply-and-demand lens — instead of the result of a series of central bank policy choices — is flawed.

The bottom line: It is a striking reminder of the extent to which the very basics of macroeconomic theory remain contested.