Federal Bond Yields

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How the Federal Funds Rate Affects 10 Year Treasury Bond Yields
______________________________________________________________________ I. Introduction The Federal Open Market Committee raised the federal funds target interest rate from the historically low 1% to 1.25% at its meeting in June 2004. Macroeconomic theory tells us that long-term interest rates tend to move in the same direction, and generally in concert with, shortterm interest rates (Abel 2005). So, we would expect the yield on a long-term asset like the10year Treasury bond, which moves directly with interest rates, to move up when a short-term rate like the federal funds rate moves up. However, a cursory
The calculated t-stats of 3.8690 and –2.6817, compared to statistical tables, show that our coefficients are significant in the model at a 95% and 99% level. Further, the calculated P-values show that if the null hypothesis of these coefficients being statistically the same as zero, and thus not having an influence on the model, were true, the probability of obtaining these t-stats is 0.0002, and .0081, respectively. We can be quite confident that our federal funds rate coefficients are significant and have a strong influence over the Treasury yield. An interval estimation construction shows that the federal funds rate (FFR1) coefficient would be somewhere between .4890 and 1.4934 with 95% certainty, and the federal funds rate (FFR2) coefficient would be between –1.0700 and –1.6430 with 95% certainty. Since the null- hypothesized value of zero is not included in either range, we can again reject the hypotheses that we have committed a Type-I error with 95% confidence. T tests show that all the explanatory variables are individually significant in the model at at least the 95% confidence level. However, we do want to test the overall significance of our estimated regression model to ensure that we have not incorrectly specified the equation and to attest to the strength of our predictive model. Judging by the significant F statistic value of 2.3117 E-53, or essentially zero, we can reject the hypothesis that the federal funds rate, unemployment rate, PPI, and our exchange rate basket, together have no effect on the 10-year Treasury yield. This gives us a high level of confidence that our model is correctly specified. Such a significant F statistic also allows us to conclude that our R2 value is highly significant as well; that indeed 84.60% of the total variability in the Treasury yield data is explained by our model. Since all of our data is