The Effect of Uncertainty on the Sensitivity of the Yield Curve to Monetary Policy Surprises

Abstract

I examine how the level of uncertainty affects the sensitivity of the U.S Treasury yield curve to monetary policy surprises. My analysis is based on a nonlinear dynamic Nelson-Siegel model of bond yields with regime shifts that depend on the level of macroeconomic uncertainty. The dynamics of the entire yield curve are captured by three latent factors, level, slope, and curvature, with exogenous monetary policy surprises affecting the yield curve through the factors. I find that uncertainty and the zero lower bound both play important roles in the yield curve’s reactions to monetary policy surprises. Specifically, during the ZLB period there is a significant increase in the sensitivity of the yield curve when uncertainty is high, with the differences being substantial in terms of the level and curvature factors.