What Moves the Bond Market?

Fleming and Remolona

Introduction

• The goal is to identify the factors that may explain large price changes and large surges in trading activity in the bond market.

• To that end, the authors instrument statistical exercises to determine the association between bond market movements and announcements of economic indicators.

Structure of the Document

• Anecdotal Evidence• Correlation of price changes and trading surges

with release times of macroeconomic conditions.

• Formal Analysis• Econometric exercise to evaluate the impact of:

» Type of announcement» Magnitude of the surprise element» Market conditions

Methodology and Data

• The bond market is represented with the five-year U.S. Treasury note.

• High-frequency intraday data for bond market activity is employed.

• Dates and release times for 21 economic indicators.

• The sample period is from August 23, 1993 to August 19, 1994.

Anecdotal Evidence

Econometric Analysis

• Run a regression

• Dependent variables:• Price volatility as measured by the percentage

change in the five minute interval following an announcement.

• Trading activity: number of transactions during the one-hour interval following the announcement.

• Independent variables: • Announcement dummy variables.

Announcement Surprises

• Add to the regression a variable to measure the surprise component of announcements:

Market Conditions• Introduce two measures of uncertainty:

• Volatility derived from options on then-year U.S. Treasury notes.

• Expected change in the fed funds rate.

Conclusions

• Each of the 25 sharpest price changes and greatest trading surges are associated with a just-released announcement.

• The largest responses are correlated, in order of importance, with the employment report, producer price index, federal funds target rate, and the consumer price index.

• Bond market activity responds significantly to the “surprise” component of announcements and market conditions.