By Trevor Hunnicutt
JACKSON HOLE, Wyo. (Reuters) – The Federal Reserve’s influence on economic conditions beyond U.S. borders may be bigger than it thinks, according to research that will be presented at the central bank’s conference on Saturday.
The new paper, “Mind the Gap in Sovereign Debt Markets,” argues that Fed policy is a chief factor determining the cost and availability of the U.S. dollar and Treasury bonds.
The research uses data on demand for Treasuries that would seem to refute Fed Chair Jerome Powell’s 2018 statement https://www.federalreserve.gov/newsevents/speech/powell20180508a.htm that “the role of U.S. monetary policy” in setting the global market conditions that can help or hurt economic growth “is often exaggerated.” The Fed was raising rates back then but last month cut borrowing costs for the first time in more than a decade to prevent a slowdown.
“There has been an active debate among policymakers about the spillovers of U.S. monetary policy to the rest of the world,” the paper said, citing Powell’s speech. “Our analysis indicates that such spillovers are intrinsic to the mechanics of international credit and currency markets.”
Investors respond directly to Fed policy, for instance reacting to higher rates by snapping up more U.S. government bonds and raising the value of the dollar, according to the paper’s authors, Arvind Krishnamurthy and Hanno Lustig at Stanford University.
Strong desire to buy U.S. assets to seek shelter from an uncertain world has been a key theme this year. The U.S.-China trade war and a teetering global economy caused investors to gobble so many 30-year Treasury bonds () in recent days that yields sank to a record-low 1.916%.
Demand for safe-haven dollar assets has grown since the 2008 financial crisis and will only gain steam, the paper’s authors conclude, despite frequent predictions that the greenback could lose ground to competing currencies.
Bank of England Governor Mark Carney, speaking on Friday at the same annual Fed retreat in Jackson Hole, Wyoming, said the dollar’s dominance increases risks to the rest of the world and said central banks might need to join together to create their own replacement reserve currency.
While strong interest in Treasuries helps the U.S. borrow at low rates, this is a double-edged sword. It allows Uncle Sam and American businesses to take on too much debt. That, in turn, could set the stage for future downturns, Krishnamurthy and Lustig wrote. Fed officials have also warned about record-high U.S. corporate debt.
Foreign investors earn “exceptionally low returns” on their Treasury investments partly because their currencies decline during panics and because they tend to buy the bonds at times when they are in high demand, according to Krishnamurthy and Lustig. They said a dependence on U.S. assets exposes those countries to risks that they cannot repay their debts if dollar-based assets are in short supply.
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