William Fung
David A. Hsieh
Fuqua School of Business, Duke University, Durham, NC 27708
Abstract
In 1994, the U.S. bond market witnessed the sharpest decline in 50 years. When the Federal Reserve raised interest rates, the 3 month Treasury bill rate rose 286 basis points, while the 30 year Treasury bond yield rose 199 basis points. An equally dramatic shift occurred with the shape of the yield curve (bond yield less bill rate) which narrowed by 171 basis points. In 1995, we saw the sharpest rally in the bond market since the October 1987 stock market crash. The first 9 months of 1995 saw the 3 month bill rate decline 72 basis points and the 30 year bond yield fall 148 basis points. Once again, the spread between them moved significantly, widening 208 basis points. To illustrate the unpredictable nature of extreme yield curve shifts, contrast the above examples to 1987. During the first 10 months of 1987, bill rate rose 189 basis points and bond yield rose 296 basis points. The spread between them in fact widened by 208 basis points. After the stock market crash, bill rate cam down by 136 basis points and bond yield fell 145 basis points. Bond to bill spread narrowed 103 basis points.