Foreign Treasury Purchases and the Yield Curve: Evidence from a Sign-Identified Vector Autoregression

Abstract

I employ a sign-identified vector autoregression (VAR) in foreign Treasury purchases and factors of the yield curve to estimate the dynamic impacts of foreign Treasury purchases on Treasury yields. Although a growing literature studies this question, it does not adequately address the endogeneity of foreign Treasury purchases to yields; not only can purchases affect yields, but yields can affect purchases. I achieve identification using sign identification and estimate effects which are larger than in most of the existing literature, but which roughly match results from event studies. This fact suggests that I successfully overcome endogeneity. Additionally, I decompose the behavior of long rates into the responses of term premia and expected future short rates. Following foreign Treasury purchases, term premia persistently and substantially decline while short rates rise with a substantial lag. This suggests that the Federal Reserve tightens policy in response to foreign purchases, but still allows a loosening of credit conditions.

Keywords: foreign Treasury purchases, capital flows, yield curve, term premium, sign identification

JEL Classification: F41, E43, F37, E58