Fed Funds Target Rose 425 Basis Points 2004-2007 While 10-Year Yield Stayed Flat at 4.73 Percent
The 2004-2007 tightening cycle demonstrates that the Fed sets one overnight price inside a larger system of market-determined rates. Long-term yields embed growth, inflation and future policy expectations, allowing borrowing costs to decouple from announced target changes. Causality runs in both directions as the FOMC and markets continuously revise views on the same underlying data.
The documented divergence shows long-term yields incorporating forward expectations rather than mechanically tracking the overnight rate. Federal Reserve Bank of St. Louis researchers Coughlin and Thornton found that after the funds rate became the explicit policy instrument, changes in the two series became uncorrelated, with the 10-year yield continuing to respond to incoming growth and inflation data even when the target remained fixed between June 2006 and September 2007. Market participants priced anticipated policy paths months ahead, so mortgage and corporate borrowing costs moved independently of contemporaneous FOMC actions.
FOMC: The 10-year Treasury yield will shift at least 25 basis points within five trading days of the next scheduled statement if core PCE deviates from consensus by more than 0.1 percentage point.
Sources (2)
- [1]Coughlin and Thornton, St. Louis Fed Working Paper(https://research.stlouisfed.org/wp/2008/2008-013.pdf)
- [2]Greenspan Testimony on the Conundrum, July 2005(https://www.federalreserve.gov/boarddocs/hh/2005/july/testimony.htm)