Yield Curve Conundrum

Abstract

Shape of Yield Curve and Industry Group Performance It is widely expected that the Federal Reserve will end the current tightening cycle early in 2006. Federal Reserve actions have a direct influence on short-term interest rates, which in turn may impact long-term rates. Long-term interest rates are influenced by (1) investors' expectation of future interest rates, (2) the risk premium demanded to hold long-term bonds, and (3) supply and demand for long-term Treasuries. We attempt to understand the impact of changes in the yield curve on the S&P 500 industry groups' performance. Monetary Policy and Equity Performance We analyzed the impact of changes in monetary policy on the equity markets. We observed industry group performance during periods of tightening and easing monetary policy from 1961 through 2005. We also looked at the changes in long-term interest rates versus the first 100-basis-point move in the Fed Funds target rate during easing and tightening periods.