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The US stock market leads the Federal funds rate and Treasury bond yields

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  • Kun Guo

    (CAS)

  • Wei-Xing Zhou

    (ECUST)

  • Si-Wei Cheng

    (CAS)

  • Didier Sornette

    (ETH Zurich)

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    Abstract

    Using a recently introduced method to quantify the time varying lead-lag dependencies between pairs of economic time series (the thermal optimal path method), we test two fundamental tenets of the theory of fixed income: (i) the stock market variations and the yield changes should be anti-correlated; (ii) the change in central bank rates, as a proxy of the monetary policy of the central bank, should be a predictor of the future stock market direction. Using both monthly and weekly data, we found very similar lead-lag dependence between the S&P500 stock market index and the yields of bonds inside two groups: bond yields of short-term maturities (Federal funds rate (FFR), 3M, 6M, 1Y, 2Y, and 3Y) and bond yields of long-term maturities (5Y, 7Y, 10Y, and 20Y). In all cases, we observe the opposite of (i) and (ii). First, the stock market and yields move in the same direction. Second, the stock market leads the yields, including and especially the FFR. Moreover, we find that the short-term yields in the first group lead the long-term yields in the second group before the financial crisis that started mid-2007 and the inverse relationship holds afterwards. These results suggest that the Federal Reserve is increasingly mindful of the stock market behavior, seen at key to the recovery and health of the economy. Long-term investors seem also to have been more reactive and mindful of the signals provided by the financial stock markets than the Federal Reserve itself after the start of the financial crisis. The lead of the S&P500 stock market index over the bond yields of all maturities is confirmed by the traditional lagged cross-correlation analysis.

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    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number 1102.2138.

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    Date of creation: Feb 2011
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    Publication status: Published in PLoS ONE 6 (8), e22794 (2011)
    Handle: RePEc:arx:papers:1102.2138

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    Web page: http://arxiv.org/

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