Foreign Official Demand for U.S. Debt and U.S. Interest Rates: Accounting for Global Common Factors

Abstract

Previous estimates of the impact of foreign official demand for U.S. Treasuries (USTs) on U.S. Treasury yields control for domestic conditions only. Yet global cyclical factors jointly shape U.S. yields and foreign demand for USTs. This paper recovers global factors from the cross-section of advanced economy sovereign bond yields, and shows that the impact of foreign official UST demand on U.S. 10-year yields is understated -- often by 50% -- when global factors are omitted. This understatement arises from the cyclical nature of UST accumulation by foreign officials, who buy (sell) USTs when safe asset yields are rising (falling) globally. Structural VAR evidence suggests that U.S. yields are particularly sensitive to official demand linked to China.

Keywords: Capital flows; Global savings glut; International reserves; Renminbi; Yuan; Neutral rates

JEL Classification: E43, E44, F21, F30, G10