The Bond Yield "Conundrum" from a Macro-Finance Perspective

Abstract

In 2004 and 2005, long-term interest rates remained remarkably low despite improving economic conditions and rising short-term interest rates, a situation that former Fed Chairman Alan Greenspan dubbed a “conundrum.”We document the extent and tim- ing of this conundrum using two empirical no-arbitrage macro-…nance models of the term structure of interest rates. These models con…rm that the recent behavior of long- term yields has been unusual— that is, it cannot be explained within the framework of the models. Therefore, we consider other macroeconomic factors omitted from the models and …nd that some of these variables, particularly declines in long-term bond volatility, may explain a portion of the conundrum. Foreign o¢ cial purchases of U.S Treasuries appear to have played little or no role.