Fed Paper: Foreign Buyers Suppress 10-Year Yield By 150 Basis Points

Wednesday, October 12, 2005

Here comes your next daily warning that it is time to look (or run?) for cover. Hat tip to The Capital Spectator who alerts us to a research paper from the Federal Reserve Board that concludes 10-year Treasury yields would currently be 150 (!!) basis points higher were it not for the massive buying of foreigners, namely foreign central banks. 10-year Treasuries yielded 4.41 % yesterday. Without the foreign purchases the yield would be 5.91 %! The abstract of the highly interesting paper "International Capital Flows and U.S. Interest Rates" (pdf) from Fed researchers Francis and Veronica Warnock goes as follows:
Foreign flows have an economically large and statistically significant impact on long-term interest rates. Controlling for various macroeconomic factors we estimate that had there been no foreign flows into U.S. bonds over the past year, the 10-year Treasury yield would currently be 150 basis points higher; even a step-down to average inflows would imply an increase of 105 basis points. The impact of the headline-making foreign official flows - a relatively small subset of total foreign accumulation of U.S. bonds - is also significant but markedly smaller. Our results are robust to a number of alternative specifications.
In the paper itself the Warnocks claim that without any official foreign inflows long-term yields would still be 60 basis points above their current level.
Fed Has Its Problems With TIC Data
I am also amused that the Fed researchers share my view, also discussed in the posts
that the Treasury Inflow Capital (TIC) data provided by the US Treasury are not really user friendly. To quote the Warnocks who point out that there is no way of knowing whether the TIC data is accurate:
"The TIC system reports monthly data on the purchases and sales of all types of long-term securities (equities as well as corporate, agency, and Treasury bonds) by all foreigners (that is, foreign officials and private investors). As such, the TIC data gives a much fuller picture of international flows into U.S. securities. It is, however, less timely than the FRBNY data, being released six weeks after month's end.
While the TIC system is more comprehensive than FRBNY's custodial reports, for at least two reasons TIC data are not as accessible to most data users. First, the data presentation is much more complicated; FRBNY publishes a single holdings number per week, whereas the TIC system publishes a myriad of time series each month. Second, the TIC transactions data are by design less accurate than FRBNY's custodial data. Rather than directly accessing investors' accounts to collect transactions data, the TIC system relies on market participants - primarily banks and broker dealers - to enter on reporting forms the amount of gross purchases and gross sales between U.S. and foreign residents. The aggregate nature of the TIC transactions data does not allow for the detailed editing and checking that is possible with security- or account-level data. This, coupled with the ever-increasing complexity of international financial systems, makes maintaining high quality data no small feat.
That said, we have no direct way of knowing whether the TIC capital flows data are accurate, in part because benchmark surveys of capital flows do not exist. However, high quality security-level benchmark surveys of foreigners' holdings of U.S. securities - surveys that recently have been conducted annually - can be used to gauge whether recorded capital flows data are reasonably accurate. Specifically, one can form flows-based holdings estimates and compare them with known holdings from the benchmark surveys. The comparison is not perfect, because unknown valuation adjustments are incorporated into the marked-to-market positions data, but large discrepancies between holdings given by the comprehensive benchmark surveys and holdings implied from capital flows data would indicate a problem with the flows data."
We learn there is always room for improvement and that nothing is more important in financial markets than the proven reliability of official sources. Money moves at the speed of a mouseclick nowadays.
As I am currently enjoying a vacation and the sun has come out again I cut off my daily post at this point, hoping to have raised enough curiosity with my readers to read the whole research paper themselves.


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