A Daily View of Yield Spreads and Short-Term Interest Rate Movements

The Fed and short-term rates: Is it open market operations, open mouth operations or interest rate smoothing?

“…29 Of course, the temporal ordering between the funds rate target and market rates is also implied by the expectations hypothesis. Support for the expectations hypothesis is generally weak, however, and is particularly weak when the short-term rate is the effective federal funds rate and the long-term rate is a short-term T-bill rate (e.g., Hardouvelis, 1988, Simon, 1990, Roberds, Runkle and Whiteman, 1996. In the absence of evidence that differentiates between these alternative explanations, the interest-ratesmoothing is as plausible an explanation as the expectations hypothesis for the observed temporal ordering.…”

The dynamic relationship between the federal funds rate and the Treasury bill rate: An empirical investigation

“…Either the Fed and the market rates responded to the same shocks and the Fed 42 In its strict form, the expectations theory has received little support, [e.g., Campbell and Shiller (1991) and Shiller, Campbell and Schoenholtz (1983)]. This is especially true when the short-term rate is the federal funds rate [Hardouvelis (1988), Simon (1990), Roberds, Runkle and Whiteman (1996) and Thornton (2000a)]. 43 The results are qualitatively the same if the tests are performed using first differences.…”

Tests of the expectations hypothesis: Resolving the anomalies when the short-term rate is the federal funds rate

“…Indeed, it is critical to many analyses of monetary policy where shorter-term rates are believed to be determined by the marketÕs expectation for the overnight federal funds rate. Hardouvelis (1988), Simon (1990) and Roberds et al (1996) investigated the expectations hypothesis (EH) using the effective federal funds rate as the short-term rate and the 3-month T-bill rate (or similar rate) as the long-term rate. With two exceptions these authors find little evidence to support the EH when the short-term rate is the federal funds rate.…”

“…All three authors find that the EH holds during this period. The second exception occurs when Roberds et al (1996) apply the test using only days when banks are required to meet Federal Reserve-imposed reserve requirements -settlement Wednesdays. While, strictly speaking, the EH is rejected when the test is applied to settlement Wednesdays, the results are much more encouraging for settlement Wednesdays than for other days during the same time period.…”