On Wednesday, Goldman was out with an interesting note on the extent to which Treasury yields react to economic data surprises.
Right off the bat that sounds boring, right? Well it’s actually not. This wasn’t just an academic exercise for the sake of meeting some research quota. It matters a great deal these days because the extent to which yields react to the data is a proxy for how the market views the Fed’s reaction function. That is, if yields stop rising/falling in response to positive/negative economic surprises, then it suggests the market no longer believes the Fed cares about the economy and is instead myopically zeroed in on financial markets both domestic and global.
In a column posted elsewhere yesterday we poked fun at the note. Specifically, we suggested that William of Occam, were he alive and playing the markets, would have been able to predict exactly what the results would be once Goldman finished what was no doubt a labor-intensive study by the economic team. Can you guess what they found out when they went to see how Treasury yields’ reaction to economic data surprises has evolved over time? Here’s a hint:
(Chart: Goldman)
That pretty much ends the data-dependency debate. Or at least it suggests that in the market’s mind, data-dependency is dead. We also said this, by way of explaining that although the results were a foregone conclusion, the note is great:
“Now let us make a couple of things clear. First of all, the note we’re referencing is actually great and those quick excerpts don't do it justice. So this isn't an attempt to disparage it. In fact, we’ll probably talk more about it later and we sincerely appreciate the analyst's work on it.”
Well we’re going to talk about it some more here.
First of all, we’re not going to get into the details behind their model. Rather, just know that what they’ve essentially done is gone a step further than what you see in the graph above by looking across the entire curve and modeling it based on reactions during three separate periods which are basically pre-crisis, post-crisis to 2014, and from 2014 to present. Here’s what they found in terms of rates’ sensitivities to economic surprises…
(Chart: Goldman)
...and here’s what they found when they replaced economic surprises with monetary policy surprises…
(Chart: Goldman)
We’ll make the obvious joke here: we’re not “surprised.”
What you see is a tendency for rates to respond more aggressively to monetary policy and less aggressively to economic surprises. Now you might think that’s intuitive. That is, why wouldn’t rates respond more dramatically to actual policy surprises than to data which is merely part of the policy reaction function? But that’s putting the cart before the horse. The market is supposed to be forward looking and if economic data inform policy, then the market should price in that data ahead of the policy decisions the data influences. Here’s a bit of color from Goldman:
“One possible explanation for this phenomenon is that investors are now more focused on Fed communications, rather than to economic data releases—perhaps due to uncertainty about the central bank’s reaction function. And we do see some evidence along these lines.”
Ummm, yes. There is indeed “some evidence along those lines.” Here to present you with “some” of that “evidence” is Citi’s Steven Englander who is a pretty smart fellow. This is from a hilarious bit of commentary entitled “Fed speeches -- where 'data dependence' goes to die”:
“In reading recent regional Fed president speeches I have been struck by the absence of the term ‘data dependence’ in the form that most of us recognize. For the USD this continues to undermine the divergence narrative. It doesn’t make the USD entirely independent of data outcomes, as we are seeing today, but investors will be very slow to price in hikes unless they get a clear indication of how the Fed will respond to data. The Fed speakers sound much more concerned about the weak side of financial markets and US and global activity than with steady progress to dual mandate targets. The absence of a concrete reference to any observable hiking trigger has led investors to be highly skeptical the Fed would be willing to hike in September under any circumstances.”
Because we couldn’t have said it any better ourselves, we’ll leave it at that.
Recent Comments