Working Paper: CEPR ID: DP17599
Authors: Rashad Ahmed; Alessandro Rebucci
Abstract: This paper shows that the price impact of foreign official (FO) purchases or sales of U.S. Treasuries (USTs) is about twice as large as previously reported in the literature once critical sources of endogeneity are addressed. We also show that prevailing estimates of this price impact suffer from omitted variable bias when foreign government bond yields and Federal Reserve policies are not controlled for. By exploiting changes in the volatility of FO flows and U.S. yields after the 2008 Global Financial Crisis, we identify a FO flow shock via heteroskedasticity in a structural VAR. We estimate that a $100B flow shock moves the 5-year, 10-year, and 30-year yields by more than 100 basis points on impact, compared to the 19-44 basis points range that we estimate by assuming FO flows are price inelastic and without controlling for foreign yields and Fed actions. Our findings suggest that FO sales of USTs played a critical role during the March 2020 episode of Treasury market turmoil, and that even a small reduction in the Dollar’s share of China’s reserves could have a significant impact on U.S. long-term interest rates.
Keywords: foreign official flows; global saving glut; identification via heteroskedasticity; interest rates conundrum
JEL Codes: E43; E44; F21; F30; G10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Foreign official (FO) flows (F21) | US Treasury yields (E43) |
| Endogeneity accounted for in FO flows (F20) | price impact of FO purchases or sales of US Treasuries (USTs) (G15) |
| Controlling for foreign yields and Federal Reserve actions (E43) | estimated impact of FO flows on yields (F69) |
| 1% reduction in China's dollar reserves (F31) | US long-term interest rates (E43) |
| FO sales during March 2020 treasury market turmoil (G10) | US Treasury yields (E43) |