Central Bank Communication Affects the Term-Structure of Interest Rates

Abstract

We empirically analyze how the Brazilian Central Bank (BCB) communication affects the term structure of future interest rates. Using principal components analysis, we construct a measure of the Monetary Policy Committee Minutes content that reflects policy makers optimism about the economic conditions. We call this measure the Optimism Factor (OF). When policy makers are more optimistic, reflected by increments in the OF, markets expectations respond and long-term future interest rates drop. Furthermore, when policy makers are pessimistic, reflected by a decrease in the OF, volatility on future interest rates increases. Our result indicates that policy maker communication has an effective impact on market expectations. Analisamos empiricamente como as atas do Banco Central do Brasil (BCB) afetam a estrutura a termos da taxa de juros. Usando Análise de Componentes Principais, construímos uma medida do conteúdo dessas atas que reflete o otimismo dos gesto-res de política monetária em relação às condições economicas. Nomeamos essa me-dida de Fator de Otimismo (OF). Quando os gestores estão mais otimistas, de forma que o OF aumenta, as taxas de juros de longo prazo caem respondendo às expectati-vas de mercados. Além disso, quando os gestores estão pessimistas, de modo que o OF cai, a volatilidade das taxas de juros futuras aumenta. Nossos resultados suge-rem que a comunicação dos gestores de política monetária tem um impacto efectivo nas expectativas do mercado.

Can Brazilian Central Bank communication help to predict the yield curve?

“…The finding that Central Bank communication helps to forecast the yield curve corroborates the argument that agents use the information published by the Central Bank to form their expectations and pricing assets. In this regard, our results are consistent with earlier studies linking Central Bank communication with the yield curve, such as Boukus and Rosenberg (2006), Chague et al (2015), Máté et al (2021), and Lucca and Trebbi (2009). While these researches focus on in‐sample analysis, our results contribute to the literature by providing out‐of‐sample evidence of the relation between the yield curve and Central Bank communication.…”

“…In this regard, the sentiment analysis of Central Bank documents may explain the behavior of the yield curve. Some researchers argue that the Central Bank communication affects short maturities of the yield curve (Boukus & Rosenberg, 2006; Chague et al, 2015), while some authors claim that long maturities (Lamla & Lein, 2011) of the yield curve are affected. These studies present only in‐sample evidence, while our investigation presents an out‐of‐sample analysis of the effects of Central Bank communication over each maturity of the yield curve.…”

“…For this reason, the yield curve plays a crucial role in the economy, requiring accurate forecasts by financial and macroeconomists. There is in-sample evidence for the relation between the Central Bank communication and the yield curve (Boukus & Rosenberg, 2006;Chague et al, 2015;Lucca & Trebbi, 2009). This relation is still little explored for outof-sample forecast analysis, although the Central Bank's words may contain new information about the future path of the yield curve.…”

“…The second branch of literature connected to this work is the one that advocates that textual analysis of documents published by the Central Bank is beneficial to understanding the term structure of interest rate (Boukus & Rosenberg, 2006;Chague et al, 2015;M até et al, 2021;Lucca & Trebbi, 2009). The explanation for using textual analysis in this context is that agents extract information from the Central Bank communications and use it when pricing assets.…”