The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models.

This paper shows that long-term forward rates move significantly in response to the unexpected components of many macroeconomic data releases and monetary policy announcements. In the pure New Keynesian model, depicted by the solid lines, the effect of the macroeconomic and monetary policy shocks on the short-term interest rate dies out very quickly, generally within a year. The interest rate displays much more persistence in the partially backward-looking model. But even in that model, the short-term interest rate essentially returns to its steady-state level well within ten years of each shock. Eleven out of the 13 variables enter the regressions with significant coefficients for the five-year-ahead forward interest rate, and ten variables enter significantly for the ten-year-ahead forward interest rate. This sensitivity of long rates is present both for indicators of inflation and for indicators of output. The federal funds futures contract for a given month settles at the end of the month based on the average federal funds rate that was realized over the course of that month. Thus, daily changes in the current-month futures rate reflect revisions to the market's expectations for the federal funds rate over the remainder of the month. Positive macroeconomic surprises lead to expectations of higher steady-state nominal interest rates, inducing a positive response in long-term forward rates.