Emerging markets economies have been a huge force behind the growth in foreign official holdings of U.S. Treasuries. Indeed, they’ve pushed up holdings from just $400 billion in January 1994 to roughly $3 trillion in June 2010. As these burgeoning economies run big current account surpluses, those savings are then channelled into foreign exchange reserves. But what would happen if those countries changed their policy direction and decided to reduce their current account surpluses? Or dampen the rate of reserves accumulation? This would clearly slow the pace of foreign official purchases of U.S. Treasury notes and bonds. But what impact would this have on long-term Treasury yields?
In their paper, “Foreign Holdings of U.S. Treasuries and U.S. Treasury Yields,” Daniel O. Beltran, Maxwell Kretchmer, Jaime Marquez, and Charles P. Thomas explore the possible outcomes, finding that such a move on the part of foreign holders would indeed make a significant impact. Note the authors:
By our estimates, if foreign official inflows into U.S. Treasuries were to decrease in a given month by $100 billion, 5-year Treasury rates would rise by about 40-60 basis points in the short run. But once we allow foreign private investors to react to the yield change induced by the shock to foreign official inflows, the long-run effect is about 20 basis points.
The full paper is published in The Journal of International Money and Finance.