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Has the Market’s Perception of the FOMC’s Reaction Function Changed since the Onset of the COVID-19 Pandemic?

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Abstract

A monetary policy reaction function typically describes how a central bank’s policy rate responds to changes in economic fundamentals, such as inflation and labor market conditions, and other factors. We use minute-by-minute data on two-year Treasury yields to study the market-expected monetary policy reaction function from 2004 to 2024. We find that financial markets expected monetary policy to react more aggressively to inflation news during 2022–2024 than in the pre-COVID-19-pandemic period. In addition, we find that the sensitivity of the two-year Treasury yield to economic news other than core inflation and labor market conditions has decreased over time. This time-varying sensitivity to changes in economic fundamentals may reflect an actual change in the FOMC’s reaction function, or it may be associated with the fact that market participants became more attentive to inflation news after the pandemic recession period.

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  • Alexander Cline & Chengcheng Jia, 2025. "Has the Market’s Perception of the FOMC’s Reaction Function Changed since the Onset of the COVID-19 Pandemic?," Economic Commentary, Federal Reserve Bank of Cleveland, vol. 2025(12), pages 1-9, November.
    • Handle: RePEc:fip:fedcec:102036
    DOI: 10.26509/frbc-ec-202512
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    1. Eric T. Swanson & John C. Williams, 2014. "Measuring the Effect of the Zero Lower Bound on Medium- and Longer-Term Interest Rates," American Economic Review, American Economic Association, vol. 104(10), pages 3154-3185, October.
    2. Michael D. Bauer & Carolin Pflueger & Adi Sunderam, 2025. "Current Perceptions About Monetary Policy," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, vol. 2025(05), pages 1-6, February.
    3. Tobias Adrian & Michael J. Fleming & Erik Vogt, 2017. "The Evolution of Treasury Market Liquidity: Evidence from 30 Years of Limit Order Book Data," Staff Reports 827, Federal Reserve Bank of New York.
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