Mind the Gap in Sovereign Debt Markets: The U.S. Treasury basis and the Dollar Risk Factor

53 Pages Posted: 8 Sep 2019

See all articles by Arvind Krishnamurthy

Arvind Krishnamurthy

Stanford Graduate School of Business

Hanno N. Lustig

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Date Written: August 1, 2019

Abstract

The U.S. dollar exchange rate clears the global market for dollar-denominated safe assets. We find that shifts in the demand and supply of safe dollar assets are important drivers of variation in the dollar exchange rate, bond yields, and other global financial variables. An increase in the convenience yield that foreign investors derive from holding safe dollar assets causes the dollar to appreciate, and incentivizes foreign debtors to tilt their issuance towards dollar-denominated instruments. U.S. monetary policy also affects the dollar exchange rate through its impact on the supply of safe dollar assets and the convenience yield. Interest rate spreads with foreign countries are not sufficient statistics to gauge the impact of the stance of U.S. monetary policy on currency markets. The U.S. Treasury basis, which measures the yield on an actual U.S. Treasury minus the yield on an equivalent synthetic U.S. Treasury constructed from a foreign bond, provides a direct measure of the global scarcity of dollar safe assets.

Keywords: safe assets, reserve currency, global financial cycle

JEL Classification: F31

Suggested Citation

Krishnamurthy, Arvind and Lustig, Hanno N., Mind the Gap in Sovereign Debt Markets: The U.S. Treasury basis and the Dollar Risk Factor (August 1, 2019). 2019 Jackson Hole Economic Symposium; Stanford University Graduate School of Business Research Paper No. 3443231. Available at SSRN: https://ssrn.com/abstract=3443231

Arvind Krishnamurthy

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Hanno N. Lustig (Contact Author)

Stanford Graduate School of Business ( email )

Stanford GSB
655 Knight Way
Stanford, CA California 94305-6072
United States
3108716532 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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