## News and Monetary Shocks at a High Frequency: A Simple Approach

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### Abstract and objective
- Develop a simple approach to identify economic news (NEWS) and monetary surprises (MONEY) at a high frequency using a bivariate structural VAR estimated at the daily frequency.
- Apply the approach to U.S. financial market developments following the Federal Reserve’s May 22, 2013 taper talk.
- Main finding: the sharp rise in 10-year Treasury bond yields immediately after May 22, 2013 was largely due to monetary policy shocks; positive economic news became increasingly important in subsequent months.

### Methodology
- Model structure:
  - Bivariate structural VAR using (log) equity prices (S, S&P 500) and 10-year Treasury bond yields (R) estimated with daily data (January 2003 to June 2014).
  - Structural shocks: NEWS (economic news) and MONEY (monetary surprises).
  - Identification via contemporaneous sign restrictions:
    - Yields (R) and Stocks (S) responses:
      - NEWS: R = + ; S = +
      - MONEY: R = + ; S = -
  - Implementation:
    - Let u contain reduced-form shocks and e contain structural shocks. Use orthonormal rotation matrices D to generate candidate decompositions that satisfy sign restrictions.
    - Steps:
      1. Draw X from N(0,1). Derive QR decomposition X = Q R such that Q is orthonormal and R is triangular.
      2. Let D = Q and compute orthogonalization P D. Keep draws that satisfy sign restrictions.
      3. Repeat until 10000 valid models are obtained.
    - Baseline model selection: choose the model that minimizes the squared distance to the median contemporaneous impulse response for both equity prices and bond yields (minimization problem described as equation (6) in the source).
- Data:
  - Daily data spanning January 2003 to June 2014.
  - R: 10-year Treasury yield at constant maturity.
  - S: (log) S&P 500 index.

### Empirical results
- Historical decomposition (January 2003–June 2014):
  - Lead up to the financial crisis: equity prices and bond yields boosted by strong economic activity; Fed tightened monetary conditions, putting upward pressure on bond yields and downward pressure on equity prices.
  - Financial crisis onset (late 2007): negative news shocks led Fed to cut policy rate to the zero lower bound (ZLB) by late 2008; adverse news continued to push yields and equity prices down while policy rates stayed at ZLB.
  - 2009–10: with rates at ZLB, markets perceived monetary conditions as too tight relative to incoming news; money shocks increased bond yields and reduced equity prices.
  - Late 2011 onward: Operation Twist (OT) — Fed bought bonds with maturities of 6 to 30 years and sold bonds with maturities less than 3 years — extended average maturity of Fed portfolio, effectively reducing long-term yields and boosting equity prices. Money shocks pushed up stocks and down long-term yields from late 2011 until May 2013.
- Daily decompositions after May 22, 2013:
  - Bond yields rose because of a combination of positive economic news and tightening money shocks.
  - Money shocks were particularly important between the FOMC statements in June and September 2013, offsetting positive economic news effects on equity prices.
  - Following the Fed’s September 2013 decision to delay tapering until 2014, monetary shocks began to unwind, boosting equity prices and putting downward pressure on yields by the end of 2013.
  - By mid-2014, the impact of monetary shocks on yields is negligible.

### Robustness checks
- Alternative samples:
  - Model estimated over September 15, 2008 (Lehman collapse) to mid-2014.
  - Model estimated from beginning of 1998 to September 14, 2008 (day before Lehman collapse).
- Alternative model-selection criteria:
  - Baseline (minimum squared distance to median for both variables).
  - Minimum squared distance to median contemporaneous impulse response for equity only.
  - Minimum squared distance to median contemporaneous impulse response for bond yields only.
  - Just-identified model where sign restriction on equity response to MONEY is relaxed (freely determined).
- Monthly VAR robustness:
  - Monthly VAR includes (log) industrial production, (log) CPI excluding food and energy, and 10-year bond yields estimated over the past 10 years and the past 15 years.
  - Identification with contemporaneous sign restrictions: demand shock increases all variables; cost-push shock increases prices and yields and reduces activity; money shock increases yields and reduces the other variables. Contribution from NEWS in Table 1 is the sum of contributions from demand and cost-push shocks.
- One-step-ahead forecast error variance decompositions from various models show similar contributions to 10-year bond yields.

### Key statistics (Table 1)
- Percent variance of bond yields explained:
  - Baseline: NEWS 0.69, MONEY 0.31
  - Post Lehman: NEWS 0.71, MONEY 0.29
  - Pre Lehman: NEWS 0.66, MONEY 0.34
  - All Weight on Bond: NEWS 0.69, MONEY 0.31
  - All Weight on Equity: NEWS 0.69, MONEY 0.31
  - Just Identified: NEWS 0.68, MONEY 0.32
  - Monthly (past 10 years): NEWS 0.63, MONEY 0.37
  - Monthly (past 15 years): NEWS 0.62, MONEY 0.38
- Interpretation: around two thirds of the variance of bond yields is driven by economic news shocks; around one third is attributable to money shocks.

### Conclusions and policy implications
- The sharp rise in 10-year Treasury yields immediately after the May 22, 2013 taper talk was largely driven by monetary policy shocks; positive economic news became increasingly important in the months that followed.
- Results are robust to different sample periods and model-selection strategies.
- Policy-relevant implications:
  - Perceptions about the current and future stance of monetary policy are important for the dynamics of long-term bond yields; about one third of variation in bond yields is attributable to money shocks.
  - Central bank transparency and communications matter given multiple objectives and instruments and prevailing uncertainties about growth, inflation, and monetary transmission.
  - To avoid undue market turbulence, central banks face the challenge of providing clear guidance about policy intentions without encouraging excessive risk taking and market volatility.
  - Communications should shift focus from explaining potential triggers of interest rate adjustment toward conveying views about policy trade-offs to address cyclical and/or financial stability concerns.

*Source: WP/14/167 — News and Monetary Shocks at a High Frequency: A Simple Approach, Troy Matheson and Emil Stavrev (September 2014).*

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