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The Employment Surprise and Bond Yields

Summary:
Given the employment surprise (NFP 266K actual vs. 978K expected), it would be remarkable if interest rates did not respond. Stock indices did drop, then recovered to pre-surprise trend. Five year bond yields did drop somewhat. Figure 1: Treasury five year constant maturity yield (blue, left scale), and TIPS five year constant maturity yield (red, right scale). Source: Treasury via FRED. Both nominal and real yields fell with the surprise, so that the simple inflation breakeven fell one bps (1.66% to 1.65%). Where does that leave inflation expectations now. Figure 2 shows the 5 year inflation breakeven as calculated conventionally (blue), and the alternative accounting for term and liquidity premia (red). Figure 2: Five year inflation breakeven calculated as five year Treasury yield

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Given the employment surprise (NFP 266K actual vs. 978K expected), it would be remarkable if interest rates did not respond. Stock indices did drop, then recovered to pre-surprise trend. Five year bond yields did drop somewhat.

The Employment Surprise and Bond Yields

Figure 1: Treasury five year constant maturity yield (blue, left scale), and TIPS five year constant maturity yield (red, right scale). Source: Treasury via FRED.

Both nominal and real yields fell with the surprise, so that the simple inflation breakeven fell one bps (1.66% to 1.65%).

Where does that leave inflation expectations now. Figure 2 shows the 5 year inflation breakeven as calculated conventionally (blue), and the alternative accounting for term and liquidity premia (red).

The Employment Surprise and Bond Yields

Figure 2: Five year inflation breakeven calculated as five year Treasury yield minus five year TIPS yield (blue), five year breakeven adjusted by term premium and liquidity premium per DKW, all in %. Source: FRB via FRED, KWW following D’amico, Kim and Wei (DKW) accessed 5/5, and author’s calculations.

In terms of the movement of the unadjusted breakeven series, one can decompose the increase in the breakeven into that coming from rising nominal yields and that coming from falling real yields.

The Employment Surprise and Bond Yields

Figure 3: Five year inflation breakeven calculated as five year Treasury yield minus five year TIPS yield (black line), and share attributed to nominal yield (blue) and attributed to real yield (brown), all in %. Source: FRB via FRED and author’s calculations.

Menzie Chinn
He is Professor of Public Affairs and Economics at the University of Wisconsin, Madison

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