The global secular decline in long-term interest rates since the 1990s has been largely driven by cumulative yield changes during U.S. monetary policy announcement windows (FOMC windows). We document this FOMC-window effect for a group of ten major advanced economies. Based on a term structure model, we show that the effect operates through the expected path of future short-term interest rates rather than term premia. We further find that the global secular decline in interest rates has been concentrated in FOMC windows preceded by macroeconomic news. We interpret this pattern as a ``Fed response to news'' channel and provide empirical evidence to support this interpretation.

We document that yield changes during the three days around U.S. monetary policy announcements (FOMC windows) account for roughly 70% of the secular decline in long-term interest rates across the ten major (G10) currencies since the 1990s. In contrast, monetary policy announcements by other G10 central banks did not have any lasting effects on their own or other foreign long-term rates. Our analysis suggests that the secular decline in global long-term bond yields reflects the combination of large cumulative declines in U.S yields and the close comovement of global bond yields in the FOMC windows. We further document that FOMC windows are associated with a cumulative depreciation of the U.S. dollar against other global currencies. This depreciation is linked to declines in the U.S. Treasury convenience yield, despite stable global yield spreads relative to U.S. benchmarks.

Exchange-rate models fit very well for the U.S. dollar in the 21st century. A “standard” model that includes real interest rates and a measure of expected inflation for the U.S. and the foreign country, the U.S. comprehensive trade balance, and measures of global risk and liquidity demand is well supported in the data for the U.S. against other G10 currencies. The monetary and non-monetary variables play equally important roles in explaining exchange rate movements. In the 1970s – early 1990s, the fit of the model was poor but the fit (as measured by t- and F-statistics, and R2s) has increased almost monotonically to the present day. We make the case that it is better monetary policy (inflation targeting) that has led to the improvement, as the scope for self-fulfilling expectations has disappeared. We provide a variety of evidence that links changes in monetary policy to the performance of the exchange-rate model.

The surge in post-COVID-19 inflation has raised critical questions about its persistence and underlying drivers. We employ a high-dimensional Factor-Augmented Vector Autoregression (FAVAR) model, utilizing Lasso techniques to simultaneously capture unobserved common factors, sectoral heterogeneity, and latent intersectoral spillovers. We find that spillovers play a dominant role in sustaining aggregate inflation, surpassing the effects of sectoral heterogeneity and common factors. During the post-COVID period, sector-specific shocks significantly contributed to the variance and persistence of aggregate inflation. Counterfactual analysis reveals that eliminating spillovers would have reduced average post-COVID inflation by 22%, with inflation reverting to the mean three quarters earlier. 

This paper studies the interaction between foreign exchange reserves and the currency composition of sovereign debt in emerging countries. Focusing on inflation targeting countries, we find that holdings of foreign reserves are associated with higher local currency sovereign debt, an exchange rate which is less sensitive to global shocks, and a lower exchange rate risk premium in local currency sovereign spreads. We rationalize these findings within a financially constrained model of a small open economy. The Sovereign values local currency debt as a hedge against endowment risk, but since the exchange rate tends to depreciate in times of global downturns, risk averse international investors charge an additional currency risk premium on this debt. When a country optimally uses foreign reserves to lean against the wind in response to global shocks, this dampens the response of the exchange rate, providing insurance for the global investor. By reducing the risk premium on local currency debt, foreign exchange reserves therefore facilitate a higher share of local currency debt in the sovereign portfolio. Quantitatively, we find the welfare benefits for the sovereign from optimal foreign reserves management can be very large.

Using a two-country model, this paper shows that the shift from foreign currency to local currency external borrowing does not eliminate the vulnerability of EMs to foreign financial shocks but instead results in “original sin redux”. A monetary tightening abroad is propagated to EM financial conditions through a tightening of foreign lenders’ financial constraints, driven in part by currency mismatches on their balance sheets. Foreign exchange intervention and capital flow management measures can mitigate global financial spillovers to EMs in the short run and a larger domestic investor base can reduce the vulnerability in the longer run.

Corporate external debt in emerging countries is very dollarized. We show this could create an externality to the sovereign and is reflected in sovereign spreads. Empirically, decomposing sovereign spreads into their credit default premium (default probability) and credit risk premium components, an increase in foreign-currency corporate debt is associated with a significant increase in the sovereign risk premium but does not change the sovereign default premium. We reconcile both findings in a quantitative model with risk-averse international investors, foreign-currency corporate debt makes the sovereign more likely to default in investors’ bad times when foreign-currency appreciates, thus increases the risk premium.