Can Treasury Markets Add and Subtract?
Treasury markets respond to the news in CBO cost estimates of individual bills about the future funding requirements from pending legislation. Treasury yields increase on days with major deficit-increasing bills, driven by an increase in expected inflation and nominal term premia, along with a decrease in convenience yields. The effects are three times larger for cost revisions for emergency spending proposals, which are unfunded and have a high probability of enactment. Our high-frequency estimates imply that a 1 percentage point one-time increase in deficits/GDP increases the 10-year nominal yield by 0.75 bps. This effect is equivalent to a 6.75 bps increase in yields for a persistent shock to deficits. Investors use these cost releases to learn about the U.S. fiscal stance. In a model with learning, we find that investors attributed a significant portion of the deficit news from cost releases to revisions in policy parameters and that 57% of the total deficit impact was expected to be unbacked.
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