Abstract: Does inflation depress the convenience yield of U.S. government debt? Using a century of data, we find Treasury convenience comoves positively with inflation during the inflationary 1970s and 1980s, but negatively in the pre-WWII period and the pre-pandemic 2000s. The positive convenience-inflation relationship is strongest for supply and core components of inflation. Higher inflation tends to lead higher convenience spreads in the 1970s and 1980s, but higher convenience spreads tend to predict declines in inflation in the data. In our equilibrium model, exogenous shocks to inflation raise nominal interest rates and the opportunity cost of holding money and money-like assets, inducing a positive inflation-convenience relationship as in the 1970s and 1980s. In contrast, exogenous shocks to liquidity preferences raise the demand for Treasuries, lower consumption demand and inflation, and induce a negative inflation-convenience relationship as seen pre-WWII and post-2000. Our theory also predicts that periods with high bond-stock betas feature a more positive inflation-convenience relationship, in line with the data. However, a direct effect of inflation depressing Treasury convenience is inconsistent with our evidence.
Zhao Jin, Central University of Finance and Economics
Jun Pan, Shanghai Jiao Tong University
Abstract: Using daily measures of stock-bond correlation, we document two distinctive pricing patterns in global markets. On days with highly negative stock-bond correlations, safety matters the most and the pricing of global assets is determined by their relative safety rather than their own fundamental risk. Examine the pricing of the U.S. Treasury market (UST) under the tale of two days, we find that on safety first days, the value of safety shrinks the UST term premium, widens the convenience yield of UST, and breaks the link between USD and UST. By contrast, on days with high stock-bond correlation, UST becomes a source of risk with increased volatility, widening term premium, and narrower convenience yield. Overall, the stock-bond correlation can be used to differentiate days of safety from uncertainty in UST and quantify the value of safety in global markets.
Abstract: The Portfolio Balance Mechanism (PBM) posits that lowering the net supply of long-term Treasuries encourages the production of similar assets for preferred-habitat investors, potentially explaining Quantitative Easing's (QE) impact on the economy and the pre-2007-2008 crisis securitization spike. This paper identifies the PBM with the 2002 suspension of 30-year Treasury bond auctions, which led to significant increases in prices and issuance of safe, long-term collateralized-mortgage obligations (CMOs) to cater to the demand from habitat-preference investors. The heterogeneity of Treasuries and CMOs provides unusually clean identification of the PBM.
Discussant: Zhaogang Song, Johns Hopkins University
Abstract: Do local-currency sovereign bonds in emerging markets work as safe assets? I estimate convenience yields arising from their safety/liquidity from both the perspective of a global and domestic investor. In a sample of 9 middle-income EMEs, I find a large convenience yield robust to both measures. The main difference with the convenience yield of U.S. Treasuries is that the global investors' convenience yield drops during episodes of high global uncertainty. I analyze two exogenous shocks to EMEs (the Taper Tantrum and Covid-19) and find that the drop in the convenience yield is not explained by the increase in credit risk or the risk premium but by a switch in investors' preferences towards a global safe asset. I set up a model of a small open economy where a foreign and a local sovereign bond earn a convenience yield from their use as collateral. The model characterizes the effect of a shock to the demand for safety and shows that the response of the local convenience yield to the global financial cycle increases the EME's volatility.
