Francis Warnock (University of Virginia) - Preferred Habitats and Timing in the World’s Safe Asset

Co-author: Alexandra Tabova (Federal Reserve System) 

Investors’ behavior in U.S. Treasuries - the world’s safe asset - affects monetary policy transmission mechanisms, fiscal policy space, loan pricing, and international vulnera[1]bilities. Yet it is not well understood for a simple reason: researchers, not having a clear picture of the Treasury portfolios of the largest participants in the market (for[1]eigners and U.S. private investors), often infer behavior from aggregate statistics that can be less than pristine. We address this by building, from confidential security-level surveys, a comprehensive dataset on the size, flows, coupon payments, and returns of foreign and U.S. investors’ Treasury portfolios. We find that investors do not view Treasuries as homogenous but have preferred habitats that determine returns: U.S. private investors hold a long-duration Treasury portfolio that delivers high average an[1]nual returns with high volatility, while foreigners have shorter-duration lower-volatility portfolios. Further, when taking into account the timing and magnitude of purchases, the actual returns earned by foreigners are higher. We also find that while foreign gov[1]ernments have inelastic demand, private U.S. and foreign investors, behind the bulk of Treasury purchases over the past decade, have elastic demand, increasing purchases of Treasuries and the duration of their Treasury portfolios when non-U.S. sovereign yields are low or decrease relative to Treasury yields. Our results shed light on the question of who will buy Treasuries as the Fed reduces the size of its portfolio and suggest that it will more likely be private investors, whether U.S. or foreign, not foreign govern[1]ments. Finally, our comprehensive security-level data also enable a critical assessment of publicly available data on foreigners’ flows.

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