Sovereign Credit Risk, U.S. Monetary Policy, and the Role of Financial Intermediaries

75 Pages Posted: 11 Oct 2023 Last revised: 4 Dec 2023

See all articles by Johannes Poeschl

Johannes Poeschl

National Bank of Denmark - Research Department

Ivan Shaliastovich

University of Wisconsin - Madison

Ram Yamarthy

Board of Governors of the Federal Reserve System

Date Written: November 30, 2023

Abstract

Using sovereign CDS data, we show that U.S. monetary policy shocks have a significant and persistent effect on global credit risk. A 25 basis point surprise in the two-year interest rate is associated with a 6.7 b.p. increase in spreads, lasting over 30 days on average. This estimate masks heterogeneity in the cross section. A one standard deviation increase in a country’s ex-ante risk, measured using market-based or political risk measures, results in an additional 4.5 to 7.3 b.p. response. The magnitudes are further affected by the health of large financial institutions. A standard deviation drop in intermediary net worth, particularly broker-dealers, doubles interest rate risk. We develop an economic model of investors, intermediaries, and heterogeneous sovereigns to rationalize these findings. The model shows that an interest rate shock results in a more constrained intermediary sector, which amplifies the reaction of sovereign credit spreads beyond pure default risk drivers.

Keywords: Sovereign Credit Risk, Monetary Policy, Financial Intermediaries, CDS, Heterogeneity

JEL Classification: E44, E52, G12, G15, G23

Suggested Citation

Poeschl, Johannes and Shaliastovich, Ivan and Yamarthy, Ram, Sovereign Credit Risk, U.S. Monetary Policy, and the Role of Financial Intermediaries (November 30, 2023). Available at SSRN: https://ssrn.com/abstract=4568379 or http://dx.doi.org/10.2139/ssrn.4568379

Johannes Poeschl

National Bank of Denmark - Research Department ( email )

Havnegade 5
Copenhagen, 1093
Denmark

Ivan Shaliastovich

University of Wisconsin - Madison ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

Ram Yamarthy (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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