Financial markets have increased their expectations that the Federal Reserve will respond more forcefully to unexpected inflation, according to new research from the Federal Reserve Bank of Cleveland. The study finds that from 2022 to 2024, two-year Treasury yields became significantly more sensitive to higher-than-expected inflation readings compared with the years before the COVID-19 pandemic.
The analysis shows that when core Consumer Price Index (CPI) readings were 1 percentage point above expectations during this period, two-year Treasury yields rose by an average of 0.71 percentage points. This is about four times greater than the sensitivity recorded in both 2004-2008 (0.18) and 2015-2020 (0.13).
Researchers Chengcheng Jia and Alexander Cline suggest that this shift may be linked to changes in public communication by the Federal Open Market Committee (FOMC), which placed a stronger emphasis on lowering inflation after the pandemic. They also propose that investors might not have focused as much on inflation-related news during years when inflation remained low and stable.
“Both explanations may play a role in accounting for the change in the market’s perceived monetary policy reaction function,” they write. “It is also possible that the two mechanisms interact with each other.”
The report further notes that while Treasury yields became more responsive to inflation surprises, their sensitivity to other economic indicators—such as core retail sales and new-home sales—declined over time.
The Cleveland Fed serves Ohio, western Pennsylvania, eastern Kentucky, and northern West Virginia through its headquarters and branches in Cincinnati and Pittsburgh. It participates in national monetary policy decisions, supervises banking organizations, supports payment systems for financial institutions and the US Treasury, and conducts research and educational outreach.
More information about these findings can be found in the Economic Commentary: Has the Market’s Perception of the FOMC’s Reaction Function Changed since the Onset of the COVID-19 Pandemic?
