The financial crisis and the changing dynamics of the yield curve

Morton L. Bech and Yvan Lengwiler (2012).

Published in BIS Papers No 65 Threat of fiscal dominance? A BIS/OECD workshop on policy interactions between fiscal policy, monetary policy and government debt management after the financial crisis Basel, 2 December 2011, Monetary and Economic Department May 2012

We present evidence on the changing dynamics of the yield curve from 1998 to 2011. We identify four different phases. As expected, the financial crisis represents a period of elevated yield volatility, but it can be split into two distinct periods. The split occurs when the Federal Reserve reached the zero lower bound. This bound suppressed volatility in the short end of the yield curve while increasing volatility in the long end — despite lower overall volatility in financial markets. In line with previous studies, we find that announcements with regard to the Federal Reserve’s large scale asset purchases reduce longer term yields. We also quantify the effect of widely observed economic news, such as the non-farm payrolls and other items, on the yield curve.