Dollar reserves and U.S. yields

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How do foreign official (FO) flow shocks impact U.S. Treasury yields, and what are the implications of changes in China's reserve composition?

View the page of: Alessandro Rebucci

Institution: Johns Hopkins University

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How do foreign official (FO) flow shocks impact U.S. Treasury yields, and what are the implications of changes in China’s reserve composition?

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This video discusses the interest rate conundrum first identified by former Federal Reserve Chairman Alan Greenspan in the early 2000s, highlighting how adjustments to the Fed fund rate did not produce expected responses in medium to long-term U.S. Treasury yields. Bernanke later framed this issue in terms of excess global savings, particularly from emerging markets like China, which affected the demand for U.S. Treasuries.

The document explores the impact of foreign official purchases and sales of U.S. Treasury securities, especially during periods of market stress, such as the disruption witnessed in March 2020. It notes that these foreign transactions can significantly influence Treasury yields, underscoring the complexities introduced by foreign accumulation of reserves and the use of the dollar in international sanctions.

The research aims to challenge conventional beliefs about foreign purchases of Treasuries being price-insensitive, utilizing publicly available data to support the analysis. The methodology includes vector autoregression to examine the interactions between foreign flows and Treasury yields and finds a substantial price impact from foreign official flows on Treasury yields, with rates dropping significantly for large-scale purchases or sales.

The study concludes that this price impact is larger than previously estimated, with immediate effects that decay over time, suggesting the dynamics of market reactions to foreign transactions have changed, particularly since the global financial crisis. The findings indicate a growing vulnerability in the U.S. Treasury market, especially in the context of potential geopolitical tensions and the challenging landscape of U.S. monetary policy normalization. The document emphasizes the need for further research into the implications of low elasticity within capital markets, particularly relating to fixed income markets and U.S. Treasuries.

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Here are five key points from the video:

1. **Interest Rate Conundrum and Saving Glut Hypothesis**: The discussion begins with the interest rate conundrum noted by former Federal Reserve Chairman Alan Greenspan, which pointed out the disconnect between the Fed's policy rate changes and the limited movement at the longer end of the yield curve. This issue was recast in terms of the saving glut hypothesis, suggesting that excessive global savings, especially from emerging markets like China, depress asset prices.

2. **Impact of Foreign Official Flows on U.S. Treasury Yields**: Recent research indicates that foreign official purchases of U.S. Treasury bonds have a significant impact on treasury yields. The findings suggest that for every $100 billion of foreign official purchases, the 10-year treasury yield could change by about 100 basis points, which is substantially higher than previous estimates in the literature.

3. **Methodological Approach and Data Limitations**: The researchers utilized the Vector Autoregression (VAR) methodology to analyze the impact of foreign official flow on treasury yields. They addressed limitations in the Treasury International Capital System data, emphasizing that not all foreign official purchases are accurately recorded and highlighting the need for flows adjusted for valuation effects.

4. **Market Dynamics During Crisis**: The video explores how foreign official selling of dollar assets tends to occur during financial crises when their exchange rates are depreciating. This behavior can exacerbate market volatility and pro-cyclicality, as demonstrated during the dislocations witnessed in the U.S. Treasury market in March 2020.

5. **Vulnerability of Financial Markets**: The study raises concerns about the vulnerability of the U.S. Treasury market, particularly in the convideo of geopolitical tensions and the use of the dollar as a sanctioning tool. With diminished market elasticity due to reduced market-making capacity from broker-dealers, the impact of foreign capital flows on treasury yields could present significant challenges, especially as monetary policy remains in transition and inflationary pressures rise.

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Here are some key quotes and ideas extracted from the video:

1. **Interest Rate Conundrum**:
- "The interest rate conundrum is something that former Chairman Greenspan raised in the early 2000s, observing that they were changing the policy rate, the Fed fund rate, and they were not seeing typical responses on the medium long end of the yield curve in the US."

2. **Global Saving Hypothesis**:
- "This conundrum was recast in terms of the savings-glut hypothesis... with a sharp increase in reserve accumulation, foreign official reserve accumulation by emerging markets, and particularly China, there could be an excess of global saving in the system."

3. **US Treasury Market Distress**:
- "More recently, the question came again to the fore with... the big dislocation in the US treasury market in March, 2020, when the market for a few days almost was frozen."

4. **Use of Dollar as a Weapon**:
- "As soon as they realized that by using the dollar as a weapon, it could be potentially deterring certain countries from wanting to have a lot of dollars because they're vulnerable."

5. **Impact of Foreign Official Flows**:
- "Bottom line is that we find significantly higher price impact of foreign official flows on the five and the ten year treasury yield... a hundred billion dollars of treasury purchases moving the 10-year yield by under basis points."

6. **High Short-Term Impact**:
- "We document the shape of this response... with very high short-term impact... and then it decays over time."

7. **Validation of Estimates**:
- "We see essentially the same multiplier that... this is very strong validation results."

8. **Market Behavior During Crisis**:
- "Foreign official buy and sell at the peak and the trough of the market... they sell dollar assets when, in times of crisis when their exchange rates are depreciating, and they buy when the dollar is very strong."

9. **Pro-cyclicality of Foreign Official Flows**:
- "These purchases and sales... exacerbate the pro-cyclicality and the natural tendency of financial markets to swing very widely."

10. **Vulnerability from Low Elasticity**:
- "This is an important source of vulnerability at times of geopolitical tensions where dollar sanctions may be used."

11. **Future Implications and Concerns**:
- "Imagine only if we were to witness a confrontation, a standoff between the US and China regarding Taiwan... $3 trillion of dollar assets in the hands of the Chinese."

12. **Importance of Understanding Capital Market Elasticity**:
- "Low elasticity in capital markets is an important issue... small flows can have a large impact on equity prices and returns."

These quotes capture the essence of the discussion regarding the behavior of foreign capital flows, the implications for US treasury yields, and the broader economic consequences of these dynamics in an increasingly interconnected financial environment.

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The original context in this,

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in which this question was raised, is that

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of the interest rate conundrum is something that,

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former Chairman Green Greenspan raised in the early

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2000, observing that they were changing the,

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policy rate, the Fed fund rate,

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and they were not seeing, typical response

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on the medium long end of the ill curve in the US

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Bernanke, which was on the board,

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and then became chairman later.

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Uh, recasted this conundrum in terms

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of the saving glass hypothesis, the idea that,

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with a sharp increase in reserve accumulation,

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foreign official reserve accumulation by emerging market,

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and particularly China, there could be an excess

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of, global saving in the system.

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Depressing, again, the most important, asset price,

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which is the price of, US treasuries.

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More recently, the question came again to the fore with,

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first of all with the big dislocation in the US treasury

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market in March, 2020 when, the market

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for a few days almost, was frozen.

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And, exposed analysis of that episode shows

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that foreign officials says of treasuries

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were a significant driver of that episode, accounting for up

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to a third of the total sales.

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Another dimension along which this question is relevant is

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in the context of the use of the dollar as a sanction.

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We saw that, after Ukraine invasion, the US boldly,

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use, access to the swift system for,

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communicating, in the interbank system.

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So excluding Russia from that system and

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therefore preventing, Russia to use,

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international financial system for,

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for commercial transaction initially was,

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was very effective, was, very welcome.

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As soon they realized that by using the dollar, as a,

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as a weapon, that could be potentially deterring,

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certain countries from, from wanting to have a lot

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of dollars because they're vulnerable to be, to be,

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caught up in, in future sanction.

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And indeed, the recent rise of the gold, is

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by many analysts being attributed in part by

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accumulation of gold as a reserve asset

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as opposed to dollars.

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And everybody's thinking about, about China here.

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When China buys,

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Uh, commodities

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or whatever is being bought, the price move very sharply.

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So, that is the broad context in which we thought

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About this.

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Our objective was very, was very narrow,

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To, Uh, revisit these broad questions,

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challenging the conventional assumption, which is

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that these foreign official purchases of US Treasury,

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bonds and nodes are not price, sensitive.

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So they are purchases made for other reasons,

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for other economic reasons, may be foreign policy reasons,

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but not, the same portfolio determinants

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of a private purchase.

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We use largely, publicly available data.

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The main source of data for, quantities

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of US treasury bonds

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and node purchased by foreigners

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is the treasury International Capital System is something

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that anybody can access on the, on the fab website.

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There are a couple problems there.

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First of all, this data do not adjust the

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recorded flows for valuation effect.

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So if we care about quantities, we need

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to separate price and quantity from the beginning.

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It's one. And then also,

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if a foreigner foreign official entity purchased

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through an intermediary, it would not be captured

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by the system because that would be, classified

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as a private purchase.

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And a team of researchers at the Fed led by,

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Carl Bert, Uh, constructed a series

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Of benchmark consistent flows,

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flows adjusted for valuation

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Effect, and trying to estimate these indirect

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Purchases. Uh, for

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example, China is understood to purchase a lot

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through, through some,

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some entities in Belgium and Luxembourg.

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That's a very good example.

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Um, and we use these benchmark consistent flows

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as our main variable.

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And then we have, we have,

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Uh, we have the yields, the bond yields at different

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maturities, and then a bunch of contra

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Variable for which is Standard macro variables

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that are available from, from public sources.

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So, n nothing, nothing particularly fancy in term

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of data where we departed in the literature.

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This question has been addressed

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essentially one way or another.

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One regressing US yield on measure

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of these foreign official flows under the assumption

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that the foreign official flows do not respond to the heel.

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So under that assumption of an elastic demand by the foreign

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official, that regression is well specified

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and is perfectly, legit to do

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so. Um, this is

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Problematic for a couple, for

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Two, three different reasons.

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Uh, the first one is that, not the totality

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of the foreign official flows can be treated

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as pricing elastic.

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So think about, sovereign wealth fund.

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They do solve the portfolio of optimization problem, and

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although not the majority, some portion of,

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reserve assets by emerging market are actively managed,

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by their own, portfolio manager,

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but also delegating to the bank of international settlement,

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for example, BIS managed actively reserve

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for, for emerging markets.

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So there is some price sensitivity,

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and if, that estimate of,

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the yield on the foreign official flows

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represent the correlation, and there are two effects, effect

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of the price on the quantity and the quantity on the price.

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And theoretically, they have opposite sign the co the,

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the correlation will be not capturing the true underlying

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causal effect of the quantity on the price.

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So that's the first one.

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Second, in the paper, we make a more nuanced point that,

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even assuming that, the foreign official flow,

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demand is completely price in elastic,

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if the private sector is price elastic,

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that could induce a bias.

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And lastly, if we are omitted important common factor,

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there could still be a bias.

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So we, we kind of justify our conjecture

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that it could be different,

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by discussing these three possibilities in the paper,

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when it come to the methodology that we, propose,

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and we used, we use these vector outer

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regression methodology.

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The vector outer regression is a system.

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You have your variable of interest.

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You assume that everything depend on everything,

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and that is just a summary, representation

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or statistical property of the data, is a, is a summary

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of the correlation structure of the data.

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Then in the VR system, identification is achieved

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by using the variance variance matrix of those variables.

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Uh, and each element of

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that variance variance matrix provide one

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identification restriction, assuming that that

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variance changes over time.

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So there is a tero spasticity, which is very

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natural assumption for, asset prices

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or for, for, for bond yields at high frequency.

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Then we have a, we, we kind

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of multiply the number of restriction.

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We keep it simple in the paper, we just split it in two

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before and after the global crisis,

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and we document that there is a lot

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of changes in the system.

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We are silent on the reason why those changes took place.

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Some of this is regulation, some of it is just how the,

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the markets change functioning after the global crisis.

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And we exploit these to obtain, six candidate shocks.

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This is statistical identification.

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So we boil down from an infinite, number of,

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possible shocks to the same number as the number

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of endogenous variable in the system.

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And then we lay over these a set of economic,

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if you will, common sense restrictions also used in the rest

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of the VR literature, to

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pin down the specific variable

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that become our, our shock.

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And essentially we ask that these shock candidate shock

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explains a lot of the foreign official flows.

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That's a natural thing to ask.

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And then we also ask that the correlation,

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between the flows and the prices, or between the quantity

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and the prices at the right sign.

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So this is called sign restriction in the literature

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and maximum variance,

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contributor shock restrictions.

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And we use those as auxiliary.

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So we kind of lower,

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the demand on this traditional approach, combining

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with the statistical technique that we use

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to identify our shock.

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Bottom line is that, we find significantly higher,

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price impact of foreign official flows on,

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the five and the, and the 10 year, treasury yield.

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The, the number is, hundred basis point

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for every hundred billion of dollar purchase or sale.

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The system is fully symmetric.

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There may be as symmetries,

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but we, we are not detecting them,

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and we have not set up the system to do so.

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So a hundred billion dollars of treasury purchases moving,

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the 10 year yield,

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obstructing from everything else by under basis point.

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This is a large estimate.

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It's potentially, an order of magnitude bigger

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than what some of the literature says a fed purchase,

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does to the treasury market.

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We are talking about, 10 basis point

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for a hundred billion dollar purchase by the Fed,

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versus a hundred, however,

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is not completely out to the ballpark.

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So by, by, by doing a mid, analysis of the study,

209
00:11:16.695 --> 00:11:20.045
especially the most recent one, other studies come up with,

210
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with numbers of these, magnitude.

211
00:11:23.325 --> 00:11:24.845
So the first finding is that

212
00:11:25.505 --> 00:11:27.445
is bigger than previously estimated.

213
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In a sense, VIN indicating the idea to try

214
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to revisit the question.

215
00:11:33.715 --> 00:11:37.645
Most importantly, we document the shape of this response,

216
00:11:37.695 --> 00:11:39.085
which is much more sensible.

217
00:11:39.225 --> 00:11:42.685
We have very high short-term impact for us,

218
00:11:42.745 --> 00:11:45.965
it means within a month, and then it decays over time.

219
00:11:46.875 --> 00:11:50.325
This is consistent with what you expect with the fact of,

220
00:11:50.505 --> 00:11:53.005
a quantit shock in asset market, right?

221
00:11:53.345 --> 00:11:54.365
It may take a while

222
00:11:54.365 --> 00:11:57.205
before figuring out the Bank of Japan, bank of China,

223
00:11:57.785 --> 00:11:59.485
or somebody else has intervened.

224
00:12:00.025 --> 00:12:03.765
Uh, but, the impact should be felt right away

225
00:12:04.345 --> 00:12:08.285
and then it should decay to whatever is is final,

226
00:12:08.595 --> 00:12:09.645
long-term effect.

227
00:12:09.825 --> 00:12:12.285
The tradi, the, the estimate exists in the leisure.

228
00:12:12.285 --> 00:12:14.765
They do the opposite. They showed that it takes up to a year

229
00:12:15.585 --> 00:12:17.645
to achieve whatever they achieve.

230
00:12:17.705 --> 00:12:21.405
So to me, this is the most important, aspect

231
00:12:21.405 --> 00:12:22.885
of our result, if you will.

232
00:12:23.865 --> 00:12:27.685
Uh, and in terms of believing the headline figure

233
00:12:27.825 --> 00:12:31.245
or not, I've been very upfront in saying that.

234
00:12:31.805 --> 00:12:33.565
I mean, there is more work to be done here.

235
00:12:33.565 --> 00:12:35.045
It seems to be a little bit too large.

236
00:12:35.865 --> 00:12:39.405
But, we did our best to validate this estimate,

237
00:12:39.635 --> 00:12:41.845
comparing to,

238
00:12:42.555 --> 00:12:46.125
what you can get from very high frequency analysis

239
00:12:46.145 --> 00:12:47.445
of Japan intervention.

240
00:12:47.575 --> 00:12:51.405
Japan intervene in the treasury mark, intervene,

241
00:12:52.105 --> 00:12:56.125
not using, draw down reserve, but purchasing

242
00:12:56.145 --> 00:12:59.285
or selling, bonds in September, 2022.

243
00:12:59.745 --> 00:13:01.485
It was the first time. After a while,

244
00:13:01.945 --> 00:13:03.565
we know exactly when it happened.

245
00:13:04.065 --> 00:13:06.445
And, we went to high frequency data

246
00:13:07.025 --> 00:13:11.605
and we see essentially the same multiplier that,

247
00:13:11.985 --> 00:13:13.405
we have estimating our data.

248
00:13:13.515 --> 00:13:17.085
This is very strong validation, results.

249
00:13:17.865 --> 00:13:21.245
Uh, but as I said, as an economist, I have to be cautious.

250
00:13:21.265 --> 00:13:22.805
And obviously there is always more to do.

251
00:13:23.345 --> 00:13:27.845
Um, it, it is on our to-do list, to, to try to,

252
00:13:28.585 --> 00:13:32.525
verify with another study what, what we found.

253
00:13:32.625 --> 00:13:36.005
But so the main summarizing bigger than previously

254
00:13:36.035 --> 00:13:40.365
estimated, stronger on impact and then dying down

255
00:13:40.945 --> 00:13:44.805
and consistent with direct measure of intervention,

256
00:13:44.805 --> 00:13:46.805
direct measure of impact of intervention

257
00:13:47.065 --> 00:13:48.605
by a large country like Japan.

258
00:13:48.795 --> 00:13:51.845
This is a complicated aspect of the question.

259
00:13:52.025 --> 00:13:54.925
We delve into it in earlier version of the paper.

260
00:13:55.325 --> 00:13:58.245
I think we have only a little bit left in the appendix,

261
00:13:58.465 --> 00:14:01.325
in the published version, but let me put it this way.

262
00:14:01.865 --> 00:14:06.685
So, foreign official buy and sell at the peak

263
00:14:06.905 --> 00:14:08.125
and the trough to market.

264
00:14:08.315 --> 00:14:12.725
They sell, dollar assets when,

265
00:14:13.185 --> 00:14:15.965
in time of crisis when their exchangers are depreciating.

266
00:14:16.065 --> 00:14:17.845
So they sell to support exchange rate,

267
00:14:18.185 --> 00:14:19.485
and they buy when the,

268
00:14:19.485 --> 00:14:22.125
when the dollar is very strong in order

269
00:14:22.145 --> 00:14:23.885
to contain appre appreciation.

270
00:14:24.785 --> 00:14:28.125
So it could be that we find these,

271
00:14:28.315 --> 00:14:30.685
high price impact precisely

272
00:14:30.685 --> 00:14:34.245
because the type of flaws that we're focusing on,

273
00:14:34.515 --> 00:14:35.925
they do,

274
00:14:36.365 --> 00:14:38.525
materialize at the peak of the trough of the market.

275
00:14:38.545 --> 00:14:39.765
That's one interpretation

276
00:14:39.765 --> 00:14:41.605
that would be an explanation on our

277
00:14:42.195 --> 00:14:44.005
high price impact findings.

278
00:14:44.475 --> 00:14:48.365
Another way to seeing the result is that if,

279
00:14:48.455 --> 00:14:52.645
these estimates are accurate, it does means

280
00:14:52.715 --> 00:14:56.005
that these, foreign official purchases

281
00:14:56.025 --> 00:15:00.885
and sales actually exacerbate those, those momentum

282
00:15:01.425 --> 00:15:02.445
in, in the market.

283
00:15:02.585 --> 00:15:04.285
And of course,

284
00:15:05.025 --> 00:15:07.405
you can immediately see it in March, 2020, right?

285
00:15:07.405 --> 00:15:11.165
If you subtract the foreign official,

286
00:15:11.475 --> 00:15:13.565
save at the time of stress in the market,

287
00:15:13.565 --> 00:15:17.125
presumably the stress in the market would not have been,

288
00:15:17.545 --> 00:15:19.285
as big as it as it was.

289
00:15:19.465 --> 00:15:23.365
So overall, again, I'm, I want to be,

290
00:15:24.465 --> 00:15:28.245
forthcoming and not, not bat my shirt on the magnet

291
00:15:28.345 --> 00:15:31.965
of our estimate and the reliability of our study,

292
00:15:32.065 --> 00:15:36.125
but it says that, these,

293
00:15:37.325 --> 00:15:40.885
purchases and sale, they exacerbate the pro cyclicality

294
00:15:40.945 --> 00:15:43.485
and the natural tendency of this, financial market

295
00:15:43.545 --> 00:15:44.805
to swing very widely.

296
00:15:45.065 --> 00:15:48.245
And we are seeing that in full play right now

297
00:15:48.245 --> 00:15:51.965
with the dollar, once again close to historical heights.

298
00:15:52.505 --> 00:15:56.725
Our main, our main point is that,

299
00:15:58.705 --> 00:16:03.165
if price impact is higher than previously assessed,

300
00:16:03.505 --> 00:16:07.965
not necessarily as high as we claim in the paper,

301
00:16:08.225 --> 00:16:10.925
in the context of a treasury market, which has

302
00:16:11.475 --> 00:16:16.205
established diminish ability to absorb, flows,

303
00:16:16.585 --> 00:16:19.805
in a context in which a treasury market has become less

304
00:16:19.875 --> 00:16:23.885
elastic, than it was in the past,

305
00:16:24.745 --> 00:16:26.925
this is an important source of vulnerability.

306
00:16:27.195 --> 00:16:29.605
This is an important source of vulnerability at the time

307
00:16:29.605 --> 00:16:33.525
of geopolitical tensions where dollar sanction may be used.

308
00:16:33.875 --> 00:16:38.285
Imagine only if, we were to witness a confrontation,

309
00:16:38.365 --> 00:16:41.805
a standoff between the US and China regarding Taiwan.

310
00:16:42.035 --> 00:16:44.645
Immediately, financial sanction would kick in,

311
00:16:45.065 --> 00:16:48.765
and you would have a confrontation between,

312
00:16:48.775 --> 00:16:53.165
$3 trillion of dollar assets in the hands of the Chinese

313
00:16:54.025 --> 00:16:58.125
and the Americans able to try to, do a lot of harm

314
00:16:58.145 --> 00:17:00.285
to China through financial sanctions.

315
00:17:00.665 --> 00:17:03.605
So it is a, it is a big deal,

316
00:17:03.985 --> 00:17:07.765
and, it is in a context, in a, of a literature

317
00:17:07.955 --> 00:17:09.885
that is paying increasingly more attention

318
00:17:10.025 --> 00:17:13.485
to these low elasticity of capital market.

319
00:17:13.585 --> 00:17:16.285
In general. This literature is very developed as far

320
00:17:16.285 --> 00:17:18.045
as equity market are concerned.

321
00:17:19.105 --> 00:17:20.805
Uh, the notion that,

322
00:17:20.895 --> 00:17:25.365
small flows can have large impact on equity, price and,

323
00:17:25.425 --> 00:17:28.765
and returns because intermediaries have mandate,

324
00:17:29.215 --> 00:17:32.445
think about mutual funds, about pension fund and et cetera.

325
00:17:32.445 --> 00:17:34.645
They cannot just, buy

326
00:17:34.645 --> 00:17:37.645
and sell in the treasury market is very well understood.

327
00:17:38.385 --> 00:17:40.885
The broker dealers do not have the same,

328
00:17:41.185 --> 00:17:43.085
market making capacity than in the past.

329
00:17:43.185 --> 00:17:44.405
So this is an important source

330
00:17:44.405 --> 00:17:48.565
of vulnerability in a context in which unfortunately,

331
00:17:48.795 --> 00:17:51.725
Normalization, monetary poly normalization in the

332
00:17:51.725 --> 00:17:52.885
US is not completed.

333
00:17:53.425 --> 00:17:55.645
Um, inflation is resurging.

334
00:17:55.745 --> 00:18:00.605
So the, interest rate, the, the,

335
00:18:00.605 --> 00:18:04.325
the Fed fund rate will take longer to reach neutral.

336
00:18:04.785 --> 00:18:09.005
And the balance sheet, of the Fed is not yet normalized.

337
00:18:09.105 --> 00:18:11.485
Not to mention that we don't know what the new normal

338
00:18:11.625 --> 00:18:13.445
for the US balance sheet is going to be.

339
00:18:14.105 --> 00:18:15.725
So, I will conclude

340
00:18:15.725 --> 00:18:18.285
by saying this is an important source of vulnerability.

341
00:18:19.025 --> 00:18:22.045
Uh, low elasticity in capital market,

342
00:18:22.825 --> 00:18:27.045
in elastic capital market is an important, issue.

343
00:18:27.265 --> 00:18:28.645
The literature, thinking about it,

344
00:18:29.185 --> 00:18:33.565
we have taken a first pass at it entirely,

345
00:18:34.035 --> 00:18:36.885
empirically, and there is more to be done when it comes

346
00:18:36.985 --> 00:18:39.165
to the fixed income market

347
00:18:39.265 --> 00:18:40.925
and particularly the US treasury market.

Global Saving and Interest Rate Dynamics: Analyzing the Conundrum

00:00:00 - The original context in this, in which this question was raised, is that of the interest rate conundrum is something that, former Chairman Green Greenspan raised in the early 2000, observing that they were changing the, policy rate, the Fed fund rate, and they were not seeing, typical response on the medium long end of the ill curve in the US

00:00:33 - and then became chairman later. recasted this conundrum in terms of the saving glass hypothesis, the idea that, with a sharp increase in reserve accumulation, foreign official reserve accumulation by emerging market, and particularly China, there could be an excess of, global saving in the system. Depressing, again, the most important, asset price,

00:01:07 - More recently, the question came again to the fore with, first of all with the big dislocation in the US treasury market in March, 2020 when, the market for a few days almost, was frozen. And, exposed analysis of that episode shows that foreign officials says of treasuries

Impact of Dollar Sanctions on Global Finance Post-Ukraine Invasion

00:01:38 - to a third of the total sales. Another dimension along which this question is relevant is in the context of the use of the dollar as a sanction. We saw that, after Ukraine invasion, the US boldly, use, access to the swift system for, communicating, in the interbank system. So excluding Russia from that system and

00:02:10 - international financial system for, for commercial transaction initially was, was very effective, was, very welcome. As soon they realized that by using the dollar, as a, as a weapon, that could be potentially deterring, certain countries from, from wanting to have a lot of dollars because they're vulnerable to be, to be,

00:02:40 - And indeed, the recent rise of the gold, is by many analysts being attributed in part by accumulation of gold as a reserve asset as opposed to dollars. And everybody's thinking about, about China here. When China buys, commodities or whatever is being bought, the price move very sharply. So, that is the broad context in which we thought About this.

Reassessing the Price Sensitivity of Foreign Purchases of U.S. Treasuries

00:03:12 - To, revisit these broad questions, challenging the conventional assumption, which is that these foreign official purchases of US Treasury, bonds and nodes are not price, sensitive. So they are purchases made for other reasons, for other economic reasons, may be foreign policy reasons, but not, the same portfolio determinants

00:03:43 - We use largely, publicly available data. The main source of data for, quantities of US treasury bonds and node purchased by foreigners is the treasury International Capital System is something that anybody can access on the, on the fab website. There are a couple problems there. First of all, this data do not adjust the recorded flows for valuation effect.

00:04:15 - to separate price and quantity from the beginning. It's one. And then also, if a foreigner foreign official entity purchased through an intermediary, it would not be captured by the system because that would be, classified as a private purchase. And a team of researchers at the Fed led by, Carl Bert, constructed a series Of benchmark consistent flows, flows adjusted for valuation

Analyzing Foreign Official Flows and U.S. Bond Yields

00:04:46 - Purchases. for example, China is understood to purchase a lot through, through some, some entities in Belgium and Luxembourg. That's a very good example. and we use these benchmark consistent flows as our main variable. And then we have, we have, we have the yields, the bond yields at different maturities, and then a bunch of contra

00:05:16 - that are available from, from public sources. So, n nothing, nothing particularly fancy in term of data where we departed in the literature. This question has been addressed essentially one way or another. One regressing US yield on measure of these foreign official flows under the assumption that the foreign official flows do not respond to the heel. So under that assumption of an elastic demand by the foreign

00:05:48 - and is perfectly, legit to do so. this is Problematic for a couple, for Two, three different reasons. the first one is that, not the totality of the foreign official flows can be treated as pricing elastic. So think about, sovereign wealth fund. They do solve the portfolio of optimization problem, and although not the majority, some portion of,

Price Sensitivity and Correlation in Foreign Official Flows

00:06:23 - by their own, portfolio manager, but also delegating to the bank of international settlement, for example, BIS managed actively reserve for, for emerging markets. So there is some price sensitivity, and if, that estimate of, the yield on the foreign official flows represent the correlation, and there are two effects, effect of the price on the quantity and the quantity on the price.

00:06:54 - the correlation will be not capturing the true underlying causal effect of the quantity on the price. So that's the first one. Second, in the paper, we make a more nuanced point that, even assuming that, the foreign official flow, demand is completely price in elastic, if the private sector is price elastic, that could induce a bias. And lastly, if we are omitted important common factor,

00:07:24 - So we, we kind of justify our conjecture that it could be different, by discussing these three possibilities in the paper, when it come to the methodology that we, propose, and we used, we use these vector outer regression methodology. The vector outer regression is a system. You have your variable of interest. You assume that everything depend on everything, and that is just a summary, representation or statistical property of the data, is a, is a summary

Identifying Shocks in Asset Price Variance Analysis

00:07:58 - Then in the VR system, identification is achieved by using the variance variance matrix of those variables. and each element of that variance variance matrix provide one identification restriction, assuming that that variance changes over time. So there is a tero spasticity, which is very natural assumption for, asset prices

00:08:31 - Then we have a, we, we kind of multiply the number of restriction. We keep it simple in the paper, we just split it in two before and after the global crisis, and we document that there is a lot of changes in the system. We are silent on the reason why those changes took place. Some of this is regulation, some of it is just how the, the markets change functioning after the global crisis. And we exploit these to obtain, six candidate shocks.

00:09:02 - So we boil down from an infinite, number of, possible shocks to the same number as the number of endogenous variable in the system. And then we lay over these a set of economic, if you will, common sense restrictions also used in the rest of the VR literature, to pin down the specific variable that become our, our shock. And essentially we ask that these shock candidate shock

Assessing Price Impact of Foreign Official Flows on Treasury Yields

00:09:36 - That's a natural thing to ask. And then we also ask that the correlation, between the flows and the prices, or between the quantity and the prices at the right sign. So this is called sign restriction in the literature and maximum variance, contributor shock restrictions. And we use those as auxiliary. So we kind of lower, the demand on this traditional approach, combining with the statistical technique that we use

00:10:06 - Bottom line is that, we find significantly higher, price impact of foreign official flows on, the five and the, and the 10 year, treasury yield. The, the number is, hundred basis point for every hundred billion of dollar purchase or sale. The system is fully symmetric. There may be as symmetries, but we, we are not detecting them,

00:10:39 - So a hundred billion dollars of treasury purchases moving, the 10 year yield, obstructing from everything else by under basis point. This is a large estimate. It's potentially, an order of magnitude bigger than what some of the literature says a fed purchase, does to the treasury market. We are talking about, 10 basis point for a hundred billion dollar purchase by the Fed,

Revisiting Impact Estimates in Asset Markets

00:11:10 - is not completely out to the ballpark. So by, by, by doing a mid, analysis of the study, especially the most recent one, other studies come up with, with numbers of these, magnitude. So the first finding is that is bigger than previously estimated. In a sense, VIN indicating the idea to try to revisit the question. Most importantly, we document the shape of this response,

00:11:39 - We have very high short-term impact for us, it means within a month, and then it decays over time. This is consistent with what you expect with the fact of, a quantit shock in asset market, right? It may take a while before figuring out the Bank of Japan, bank of China, or somebody else has intervened. but, the impact should be felt right away and then it should decay to whatever is is final,

00:12:09 - The tradi, the, the estimate exists in the leisure. They do the opposite. They showed that it takes up to a year to achieve whatever they achieve. So to me, this is the most important, aspect of our result, if you will. and in terms of believing the headline figure or not, I've been very upfront in saying that. I mean, there is more work to be done here. It seems to be a little bit too large. But, we did our best to validate this estimate,

Japan's Bond Market Intervention: Insights and Implications

00:12:42 - what you can get from very high frequency analysis of Japan intervention. Japan intervene in the treasury mark, intervene, not using, draw down reserve, but purchasing or selling, bonds in September, 2022. It was the first time. After a while, we know exactly when it happened. And, we went to high frequency data and we see essentially the same multiplier that,

00:13:13 - This is very strong validation, results. but as I said, as an economist, I have to be cautious. And obviously there is always more to do. it, it is on our to-do list, to, to try to, verify with another study what, what we found. But so the main summarizing bigger than previously estimated, stronger on impact and then dying down and consistent with direct measure of intervention,

00:13:47 - by a large country like Japan. This is a complicated aspect of the question. We delve into it in earlier version of the paper. I think we have only a little bit left in the appendix, in the published version, but let me put it this way. So, foreign official buy and sell at the peak and the trough to market. They sell, dollar assets when, in time of crisis when their exchangers are depreciating.

Impact of Foreign Official Purchases on Market Dynamics

00:14:18 - and they buy when the, when the dollar is very strong in order to contain appre appreciation. So it could be that we find these, high price impact precisely because the type of flaws that we're focusing on, they do, materialize at the peak of the trough of the market. That's one interpretation that would be an explanation on our high price impact findings. Another way to seeing the result is that if,

00:14:52 - that these, foreign official purchases and sales actually exacerbate those, those momentum in, in the market. And of course, you can immediately see it in March, 2020, right? If you subtract the foreign official, save at the time of stress in the market, presumably the stress in the market would not have been, as big as it as it was.

00:15:24 - forthcoming and not, not bat my shirt on the magnet of our estimate and the reliability of our study, but it says that, these, purchases and sale, they exacerbate the pro cyclicality and the natural tendency of this, financial market to swing very widely. And we are seeing that in full play right now with the dollar, once again close to historical heights.

Assessing Vulnerability in Treasury Markets Amid Geopolitical Tensions

00:15:58 - if price impact is higher than previously assessed, not necessarily as high as we claim in the paper, in the context of a treasury market, which has established diminish ability to absorb, flows, in a context in which a treasury market has become less elastic, than it was in the past,

00:16:27 - This is an important source of vulnerability at the time of geopolitical tensions where dollar sanction may be used. Imagine only if, we were to witness a confrontation, a standoff between the US and China regarding Taiwan. Immediately, financial sanction would kick in, and you would have a confrontation between, $3 trillion of dollar assets in the hands of the Chinese and the Americans able to try to, do a lot of harm

00:17:00 - So it is a, it is a big deal, and, it is in a context, in a, of a literature that is paying increasingly more attention to these low elasticity of capital market. In general. This literature is very developed as far as equity market are concerned. the notion that, small flows can have large impact on equity, price and, and returns because intermediaries have mandate,

Vulnerabilities in the US Treasury Market Amid Monetary Uncertainty

00:17:32 - They cannot just, buy and sell in the treasury market is very well understood. The broker dealers do not have the same, market making capacity than in the past. So this is an important source of vulnerability in a context in which unfortunately, Normalization, monetary poly normalization in the US is not completed. inflation is resurging. So the, interest rate, the, the,

00:18:04 - And the balance sheet, of the Fed is not yet normalized. Not to mention that we don't know what the new normal for the US balance sheet is going to be. So, I will conclude by saying this is an important source of vulnerability. low elasticity in capital market, in elastic capital market is an important, issue. The literature, thinking about it, we have taken a first pass at it entirely,

00:18:39 - to the fixed income market and particularly the US treasury market.

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