Michael Dueker

English

Research Papers in Economics

FOMC Decisions and
Bond Market Uncertainty
Monetary policy decisions by the Federal Open
Market Committee (FOMC) affect market perceptions
of the degree of uncertainty about the future course of
interest rates.  The FOMC influences expectations about
interest rates most directly by changing its target for
the federal funds rate and by announcing its bias with
respect to possible future target changes.  Because the
FOMC tends to adjust the fed funds target rate in a
series of increments, a single target change can induce
relatively large revisions to market expectations.
Furthermore, starting with its May 18, 1999, meeting,
the FOMC has announced its adopted bias for possible
future target changes at the conclusion of each meeting.
Information about the bias might affect market uncer-
tainty about the future course of interest rates.  For
example, a switch from a bias to tighten to a symmetric
stance may lead bond market participants to believe
that a series of interest-rate hikes has concluded or that
the series will be more gradual.
To examine the relationship between FOMC decisions
and bond market uncertainty, an index of bond yield
volatility is useful because higher volatility reflects
greater uncertainty about future bond yields.  The
Merrill Option Volatility Expectations (MOVE©) is one
such measure that covers a wide range of maturities of
Treasury bonds.  Analysts estimate the implied volatili-
ties corresponding to at-the-money options with one
month to expiration on Treasury bonds with maturities
of two, five, 10 and 30 years.  These four implied
volatilities are aggregated with weights determined by
the approximate volume of options traded on each
bond.  Because a given term structure of interest rates
maps onto a sequence of implied forward short-term
rates (see page 11), uncertainty about the future behav-
ior of bond yields is equivalent to uncertainty about
the future course of short-term interest rates.
The accompanying chart shows the behavior of the
MOVE bond volatility index for 10 business days
before and after each FOMC meeting since August
1998, including the Oct. 15, 1998, conference call.1
At the top of the chart, the change in the federal funds
target rate and the FOMC’s bias are noted for each
meeting (+ for a bias toward future tightening and –
for a bias toward easing).  The 25-basis point cut in
the fed funds target rate in November 1998—the third
such move that autumn—clearly reduced bond market
uncertainty, as markets were apparently convinced that
the FOMC’s actions were consistent with a continued
calming of that autumn’s financial market upset.
Since May 1999, bond market uncertainty has tended
to increase slightly when the FOMC announced a bias
toward future tightening but did not change its target
for the fed funds rate.  On the other hand, none of the
three 25-basis point increases in the funds target rate
since June 1999 appreciably affected bond market
uncertainty, perhaps because each was accompanied
with an announced symmetric stance looking forward. 
—Michael Dueker
January 2000
MonetaryTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
1 Data provided by Merrill Lynch.

FOMC decisions and bond market uncertainty

http://research.stlouisfed.org/publications/mt/20000101/cover.pdf

FOMC decisions and bond market uncertainty

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Research Papers in Economics