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Lead-Lag Links Between the S&P 500, Federal Funds Rate, and Treasury Yields

Article arXiv papers · Author: Kun Guo et al.
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Summary

This study tests two expectations about fixed-income relationships: that stock prices and yields move in opposite directions, and that central bank rate changes help predict later stock-market direction. It applies the thermal optimal path method to monthly and weekly observations of the S&P 500, the Federal funds rate, and Treasury yields across short and long maturities, with lagged cross-correlation as a traditional comparison.

The reported patterns run counter to both expectations: stocks and yields move in the same direction, and the S&P 500 leads yields, particularly the Federal funds rate. The study also reports a change in the lead-lag relationship between short- and long-maturity yields around the financial crisis that began in mid-2007. The authors interpret these findings as evidence that policy and long-term investors may respond to stock-market signals. These are historical time-series associations; the excerpt does not establish causation or show that the relationships remain stable or provide a profitable trading signal.

Key ideas

  • The study uses thermal optimal path analysis to estimate changing lead-lag links in economic series.
  • It compares monthly and weekly S&P 500 data with central bank rates and Treasury yields.
  • The reported stock and yield movements are positively aligned, contrary to the tested expectation.
  • The S&P 500 is reported to lead yields across maturities, including the Federal funds rate.
  • The reported lead between short- and long-term yields reverses after the financial crisis began.

Tags

EquitiesFixed incomeUS marketsStatistics
Full text
# The US stock market leads the Federal funds rate and Treasury bond yields


# The US stock market leads the Federal funds rate and Treasury bond yields









Using a recently introduced method to quantify the time varying lead-lag dependencies between pairs of economic time series (the thermal optimal path method), we test two fundamental tenets of the theory of fixed income: (i) the stock market variations and the yield changes should be anti-correlated; (ii) the change in central bank rates, as a proxy of the monetary policy of the central bank, should be a predictor of the future stock market direction. Using both monthly and weekly data, we found very similar lead-lag dependence between the S&P500 stock market index and the yields of bonds inside two groups: bond yields of short-term maturities (Federal funds rate (FFR), 3M, 6M, 1Y, 2Y, and 3Y) and bond yields of long-term maturities (5Y, 7Y, 10Y, and 20Y). In all cases, we observe the opposite of (i) and (ii). First, the stock market and yields move in the same direction. Second, the stock market leads the yields, including and especially the FFR. Moreover, we find that the short-term yields in the first group lead the long-term yields in the second group before the financial crisis that started mid-2007 and the inverse relationship holds afterwards. These results suggest that the Federal Reserve is increasingly mindful of the stock market behavior, seen at key to the recovery and health of the economy. Long-term investors seem also to have been more reactive and mindful of the signals provided by the financial stock markets than the Federal Reserve itself after the start of the financial crisis. The lead of the S&P500 stock market index over the bond yields of all maturities is confirmed by the traditional lagged cross-correlation analysis.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.