The Impact of Monetary Policy on Yield Curve Expectations

A great deal of monetary policy is aimed at steering market expectations but little is known about agents belief formation. This article investigates how US market participants adjust yield curve expectations in response to two shocks related to monetary policy. The results show that in the aggregate, market participants initially underreact to changes in monetary policy. This implies that news are not fully absorbed, which potentially impedes a smooth monetary policy transmission. We further show that these information rigidities could be driven by a lack of information diffusion among individual forecasters. Last, we find that depending on the source of the shock and the maturities of the yields, underreaction is followed by a period of overcompensation a pattern called delayed overshooting. Knowing this allows the central bank to better calibrate their actions in the first place, which could pave the way for more optimal monetary policy.