Is the Risk-Free Yield Is the Risk-Free Yield Curve a good Predictor of Curve a good Predictor of

Outcomes in Various Outcomes in Various Types of Bond Markets?Types of Bond Markets?

Types of BondsTypes of Bonds

US TreasuryUS Treasury MunicipalMunicipal CorporateCorporate MBSMBS ABSABS GSEGSE

Risk associated with Risk associated with BondsBonds

Interest rateInterest rate CreditCredit InflationInflation CallCall PrepaymentPrepayment Reinvestment Reinvestment

Yield CurveYield Curve

Important for economyImportant for economy Use as a Predictor of economyUse as a Predictor of economy

Yes: Estrella & Mishkin titled Yes: Estrella & Mishkin titled No: Haubrich & Dombrosky : “the yield No: Haubrich & Dombrosky : “the yield

curve was the worst forecast we curve was the worst forecast we examined.” examined.”

Timing (last predicted recession)Timing (last predicted recession)

Bond MarketBond Market

Total US outstanding: $25.8 trillionTotal US outstanding: $25.8 trillion Risk Free: 16.7%Risk Free: 16.7% Table of composition:Table of composition:

Total US outstanding Total US outstanding bond debtbond debt

MBS 23.56% 6,095.20 MBS 23.56% 6,095.20 billionsbillions

Corporate 19.70% 5,095.10Corporate 19.70% 5,095.10 Treasury 16.70% 4,321.70Treasury 16.70% 4,321.70 Money Market 13.50% 3,497.40Money Market 13.50% 3,497.40 GSE 10.20% 2,641.20GSE 10.20% 2,641.20 Municipal 8.70% 2,255.90Municipal 8.70% 2,255.90 ABS 7.60% 1,965.50ABS 7.60% 1,965.50 Total  25,872.00Total  25,872.00

ConceptConcept

Yield curve: effect on other bond yield Yield curve: effect on other bond yield curvescurves

Effect on:Effect on: Sectors of economySectors of economy Geographic locations in USGeographic locations in US

Good predictor:Good predictor: The Municipal Bond Credit ReportThe Municipal Bond Credit Report Flattening of muni composite yield curveFlattening of muni composite yield curve

ConceptConcept

PlanPlan

Comparison of rates among different Comparison of rates among different type of bondstype of bonds

30 year Treasury bond & 30 year 30 year Treasury bond & 30 year conventional mortgage rate compared conventional mortgage rate compared by monthly changes in ratesby monthly changes in rates

Long-term year Treasury bond & Long-term year Treasury bond & Moody’s Aaa Corporate bond compared Moody’s Aaa Corporate bond compared by monthly changes in ratesby monthly changes in rates

AnalysisAnalysis

Bond Comparison Rates

0.001.002.003.004.005.006.007.008.009.00

Jan-

98

Jul-9

8

Jan-

99

Jul-9

9

Jan-

00

Jul-0

0

Jan-

01

Jul-0

1

Jan-

02

From Jan. 1998 to Feb. 2002

Rat

e

30 Year TresauryBond

30 Year ConventionalMortgage

Moody's Aaa CorpBond

AnalysisAnalysis

Monthly Rate Variations

-0.50-0.40-0.30-0.20-0.100.000.100.200.300.400.50

From Jan. 1998 to Feb. 2002

Ch

ang

e in

rat

e

30 Yr. Treasury Bond

30 Yr. Conventional Mortgage

AnalysisAnalysis

Monthly Rate Variations

-0.50

-0.40-0.30

-0.20

-0.100.00

0.10

0.200.30

0.40

From Jan. 1998 to Feb 2002

Ch

ang

e in

Rat

e

Long-term TreasuryBond

Moody's AaaCorporate Bond

ConclusionsConclusions

Current research correctCurrent research correct Bond yields: do not lag to risk-free Bond yields: do not lag to risk-free

raterate Bond yields: other factors that do Bond yields: other factors that do

not represent the normal yield curvenot represent the normal yield curve

ImplicationsImplications Fed:Fed:

see impact in different sectors of economy.see impact in different sectors of economy. CFO’s, CEO’s:CFO’s, CEO’s:

use yield curve for finance decisionsuse yield curve for finance decisions State, counties, cities:State, counties, cities:

use curve to make decisionsuse curve to make decisions Real estate investors, homebuyers and Real estate investors, homebuyers and

others:others: pay attention to yield curvepay attention to yield curve

Inherent Bond characteristics:Inherent Bond characteristics: important to knowimportant to know

Questions?Questions?