Monetary policy's time-varying impact on the US bond markets: Role of financial stress and risks

• This paper models the yield curve's response to monetary policy surprises.
• We use TVP model and further study the role of financial market risks.
• There is significant time variation in the impact of policy shocks on interest rates.
• The time variation in the response is a function of risks in the financial markets.
• Increased financial risks lowers policy effectiveness on longer term rates.

This paper provides a novel analysis on the Treasury yield curve's response to monetary policy shocks and the role of financial market volatility and risks in assessment of the monetary policy impact. The results show that unlike the fixed coefficient approach usually used in the literature, the time varying parameter framework of the paper is needed to aptly unveil the latent dynamics of monetary policy impact on the bond markets. Wide time variation exists in the response of bond yields across all the maturities to the Federal Reserve's policy surprises. While the short-term rates respond more widely even the long-term rates show significant variation. Further, these time varying policy effects on interest rates are inversely related with the level of financial risks and economic uncertainty. These results are robust to several alternative aspects of risk and uncertainty.