Research

This paper investigates how the role of US Treasuries as global safe, liquid asset shapes the return sensitivity of foreign demand and, in turn, the Treasury rate of return in equilibrium. A portfolio choice model featuring investors with heterogeneous preferences for US Treasuries shows that when investors value liquidity, their portfolio allocations become less sensitive to the mean and variance of excess returns. In equilibrium, Treasury excess returns are lower but more responsive to changes in debt supply. Structural parameters estimated from European data reveal that  the special role of Treasuries considerably dampens investors’ yield sensitivity across sectors, and lowers Treasury yields by up to 7 basis points. The official sector stands out as the main source of convenience yields, contributing 4 basis points. At a time of high and rising public debt, these results highlight the vulnerability of US fiscal sustainability to any erosion of the status of US Treasuries as global safe asset.

This paper introduces a new mechanism to reconcile the empirical evidence of real exchange rate depreciation in response to fiscal shocks for the United States with models of open economies with sticky prices and complete markets. The mechanism hinges on the convenience yield of U.S. Treasuries and on the fraction of government spending financed by debt. In a model with fixed real rates, a fiscal shock financed at least in part by debt causes a drop in the convenience yield and a substitution towards higher consumption, resulting in a real exchange rate depreciation through international risk sharing. On the other hand, when the real interest rate is not fixed, the interactions between fiscal and monetary policy matter. Under fiscal dominance, the real exchange rate depreciates, but the convenience yield rises. Under monetary dominance, debt-funded fiscal shocks deliver a drop in the convenience yield, and a real depreciation as long as the nominal rate does not react too strongly to inflation. The paper also provides evidence that in the U.S. tax-financed fiscal shocks lead to an appreciation of the exchange rate and a higher convenience yield; while debt-financed shocks lead to a depreciation and lower convenience yield, consistently with the model.

The fiscal sustainability of US public debt depends crucially on the convenience yield, the premium that investors pay to hold US Treasuries. Theoretically, equilibrium government debt supply is negatively associated with the convenience yield, which is also linked to the exchange rate through interest parity. However, the existing literature offers only correlational evidence, disregarding the active choice of debt issuance by the government. Using a simple open-economy model with optimal debt supply and liquidity preference for Treasuries, we show that outward shifts in debt supply reduce the convenience yield through dollar depreciation. Conversely, changes in liquidity preference generate positive comovements between debt supply, currency appreciation, and convenience yields. As a result, estimation strategies, like OLS, that fail to disentangle Treasury supply and demand shocks result in an understatement of the yield elasticity of Treasury demand, and of the impact of Treasury supply shocks on exchange rates. We confirm the predicions of our model via local projections using an instrument based on Treasury futures price changes following auction announcements. An unexpected rise in US Treasury supply lowers the convenience yield and depreciates the dollar against G10 currencies by up to three times more than previously esimated.

This paper investigates the sensitivity of the demand for safe government debt to currency unhedged and hedged excess returns in a sample of US mutual funds. We find evidence of active rebalancing towards government bonds that offer relatively higher returns on an unhedged basis, in particular euro-denominated securities. The size of the effect is large, leading to a change in portfolio share by around one percentage point on average in response to a change by one percentage point in the currency-specific excess return. Interestingly, mutual funds rebalance their portfolio towards currencies, such as the Japanese yen, that display large deviations in the covered interest parity and offer higher returns than US Treasuries on an hedged basis. Finally, when global financial risk is on the rise, US mutual fund managers repatriate their investments towards US government debt securities, mainly at the expenses of euro-denominated ones. Our results  imply that deviations in pricing conditions like uncovered and covered interest parity for sovereign bonds affect capital flows from the United States towards other major currency areas. 

We study the spillovers of large-scale asset purchases (LSAPs) in the U.S. on financial intermediation in the euro area using bank-level supervisory data and high-frequency identified policy surprises. Our detailed panel data permit us to trace the impact of LSAPs through bank balance sheets. We find that the Federal Reserve affects credit provision in the euro area through a channel that we refer to as the ``international bank capital channel'' of unconventional monetary policy. In response to an LSAP shock that leads to a steepening of the U.S. Treasury yield curve, the Treasury positions of euro area banks shrink, capital ratios worsen, and banks that are less well capitalized contract their lending relative to banks that are better capitalized. Our results are consistent with an important role of revaluation effects, imperfect risk hedging, and credit as an adjustment margin for banks in the proximity of regulatory capital constraints.