Template-Type: ReDIF-Paper 1.0
Author-Name: Andreas Schrimpf
Author-X-Name-First: Andreas
Author-X-Name-Last: Schrimpf
Author-Name: Markus Sihvonen
Author-X-Name-First: Markus
Author-X-Name-Last: Sihvonen
Title: Inflation and the joint bond-FX spanning puzzle
Abstract: We generalize the yield spanning condition in the bond literature to non-linear models and to exchange rates. In standard macro-finance models, no variable should predict yield or exchange rate changes once standard yield curve factors are controlled for. We provide novel evidence that this spanning condition is violated, with inflation as a common unspanned predictor of both bond and exchange rate returns. Investors' incomplete information about the Federal Reserve's monetary policy rule emerges as the key driver of this result. We find high inflation to be followed by unexpected monetary policy tightening, which leads to dollar appreciation and low bond returns. We explain these findings by a simple model that departs from full information rational expectations.
Creation-Date: 2025-12
File-URL: https://www.bis.org/publ/work1320.pdf
File-Format: Application/pdf
File-Function: Full PDF document
File-URL: https://www.bis.org/publ/work1320.htm
File-Format: text/html
Number: 1320
Keywords: inflation, bond markets, exchange rates, central bank reaction function, investor expectations
Classification-JEL: G12, E43, E58
Handle: RePEc:bis:biswps:1320