Monetary policy expectations and financial Markets: A Quantile-on-Quantile connectedness approach

Abstract

This study investigates how the United States (US) monetary policy expectations impact various financial market segments using a quantile-on-quantile connectedness approach. It employs the USD 1-year interest rate swap (1YUSA) as a proxy for these expectations. It also examines the interconnectedness between these expectations and key financial markets, including stocks, bonds, exchange rates, and derivatives. The analysis reveals a complex, nonlinear relationship. The impact of monetary policy expectations varies significantly across different market conditions and quantiles. Strong connectedness is particularly evident during extreme market conditions, with heightened sensitivity during periods of economic uncertainty or anticipated policy shifts. The results demonstrate that monetary policy expectations disproportionately influence financial markets, particularly during market stress. The strongest effects appear in the lower quantiles of interest rates and the upper quantiles of market indices. These findings are crucial for policymakers and investors, providing deeper insights into the market’s response to monetary signals. They also enhance strategies for risk management and policy formulation in an increasingly volatile global financial environment.