The Treasury Tantrum of 2023

What it says

In the second half of 2023 the 10-year Treasury yield climbed from below 4 percent to above 5 percent, then fell back to 3.9 percent. The authors ask how much of each leg reflected expected policy rates and how much the term premium, because the answer changes how policy should respond: a premium-driven rise tightens financial conditions by itself, while an expectations-driven rise implies a higher rate path. Comparing three Fed-system term structure models with survey measures, they conclude the climb was mostly term premium, linked to quantitative tightening, heavier issuance and greater uncertainty, while the decline leaned more on expectations after softer data. Averaging the models yields a simple rule: steepening of the 10s-2s slope maps almost one for one into term premium, and a move in the 2-year splits roughly half and half. Surveys, they show, react to markets with a lag.

What to take from it

1. 1

   From late July to October 2023 the 10-year rose close to 115 basis points, above the 99th percentile of comparable moves since 1990.

2. 2

   Rule of thumb: a change in the 10s-2s slope passes roughly one for one into the 10-year term premium; a change in the 2-year yield splits about evenly.

3. 3

   Yields-only models are sensitive to their sample: ACM starts in 1961, when short rates averaged higher, so it assigns more to expectations and less to term premium than CR.

4. 4

   Changes in survey expectations can be predicted from past yield moves, evidence that forecasters respond to markets with a delay.

5. 5

   The authors find the 2022 hiking cycle most resembled 1994, the one cycle in their comparison that did not end in recession.

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