The US Term Premia around the FOMC Decisions

Using the high-frequency identification from Piazzesi (2005), this study estimates a Gaussian term structure model on daily US interest rates data to explore the reaction of the estimated term premia on the Federal Open Market Committee (FOMC) policy rate decisions. All the FOMC decisions from January 1999 to December 2008 are divided into anticipated- and "surprise" policy actions, following Kuttner (2001). A separate set of parameters is estimated for the policy days. The estimation results suggest that the expansionary policy actions, considered as anticipated, cause on average a contemporaneous decline in forward term premia and a rise in the short-rate expectations on the longer-end of the curve. A surprise cut seem to provoke a parallel shift of the expected short-rates and a spike in longer term premia. This negative co-movement between the premia and the short-rate expectations, implicit in higher maturities, might provide one explanation of the so called "slope effect" of monetary policy on the US yield curve. The findings are independent of the market price of risk specification or whether the model with a single- or two parameter set is used in the assessment. Nonetheless, allowing a separate set of parameters around policy action days indicates a greater role of the slope factor in explaining the variation of long-term yields around those days.