AI Summary
5 min readWhy Treasuries Are 'Risky' Again
As of late September 2025, the 30-year Treasury yield had climbed to 5.59% — the highest level since 2002. This surge came even after the Federal Reserve raised rates at Jackson Hole, raising an uncomfortable question: if rate hikes are supposed to tighten financial conditions, why are yields still soaring? To make sense of this, the Odd Lots podcast brought on Carolyn Pflueger, an associate professor at the University of Chicago Harris School and a visiting scholar at the Chicago Fed, whose research examines how bond markets reflect and shape the macroeconomy.
The Market's Perceived Policy Reaction Function
Pflueger's central concept is the "perceived policy reaction function" — what markets and forecasters expect the Fed to do in response to economic conditions. If inflation runs at 4% and forecasters expect a 6% policy rate, that implies a reaction coefficient of one. This matters because a well-understood reaction function means markets adjust to economic data before the next FOMC meeting, effectively doing the Fed's work for it.
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What you'll learn
- 1 (05:06) **Guest Introduction & Research Focus** - Carolyn Pfluger introduces her work on how the macroeconomy, monetary policy, and inflation are reflected in and shaped by bond markets.
- 2 (06:17) **Defining the "Policy Reaction Function"** - A clear definition of what this is and why it matters for monetary policy transmission.
- 3 (07:56) **Two Methods for Measuring the Reaction Function** - Explains the survey-based and market-based methodologies used to quantify market perceptions.
- 4 (12:08) **What Moves the Perceived Reaction Function?** - The key finding that the market learns primarily from the Fed's actions, not its words.
- 5 (19:52) **Stability vs. Discretion in the Reaction Function** - Discusses whether a perfect central bank would have a perfectly stable reaction function.
- 6 (22:24) **The Trade-Off of Action vs. Gradualism** - Explores the risk of requiring painful action to establish credibility and the return of bond risk.
- 7 (24:14) **Decomposing the Return of Bond Risk** - Explains the role of inflation and the nature of economic shocks in driving bond-stock correlation.
+ Full timestamped outline available in the app
Show Notes
We all know that US Treasury yields have been surging, alongside bond yields all around the world. So what explains the selloff and does this mean that bonds are becoming fundamentally riskier? What happens if investors can no longer hedge stocks with government debt? And how do expectations of the Federal Reserve's "reaction function" fit in? In this episode, we speak with Carolin Pflueger, associate professor at the University of Chicago and a resident scholar at the Chicago Fed Bank, about her work on the bond market and central banks. We discuss why bonds have become more stock-like, what that means for yields, and the role of the Fed's credibility in making bonds “bond-like” again.
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