U.S. risk and convenience yield
In this paper, Corsetti et al. examine the relationship between perceived U.S. risk and the convenience yield of U.S. Treasuries. The authors develop a two-country no-arbitrage model that includes a rich maturity structure of bonds and convenience yields. The model links carry-trade returns, cross-border convenience yields, and relative country risk across different maturities. Corsetti et al. then construct novel empirical measures of country risk from bond and equity premia, adjusting for within-country convenience yields. Their main findings include:
- Rising U.S. Risk Relative to Other G7 Economies: Over the past two decades, investors’ perceptions of U.S. risk have increased relative to other G7 economies. This increase is primarily driven by expectations of greater long-run (permanent) risk in the U.S.
- Decline in Convenience Yields of Long-Maturity U.S. Treasuries: There has been a notable decline in the convenience yields that foreign investors attach to long-maturity U.S. Treasuries. Specifically, a 1 percentage point (pp) increase in perceived U.S. permanent risk is associated with a 3-7 basis points (bp) fall in convenience yields. The authors argue that the rise in U.S. risk and the fall in long-maturity U.S. Treasuries’ convenience yields are interconnected phenomena.
- Implications for Carry-Trade Returns: The analysis shows that the direct and indirect effects of higher risk on carry-trade returns offset each other in the long run. In the short run, these effects do not offset, leading to different dynamics in short-term versus long-term carry-trade returns.
U.S. Risk and Treasury Convenience
Authors: Giancarlo Corsetti, Simon Lloyd, Emile Marin, Daniel Ostry
From: European University Institute, Bank of England, University of California, Davis
If demand for U.S. Treasuries bonds dried up, which metrics will flash red
David Wessel explains in this commentary explains that there are behind-the-scenes measures of whether there are “enough” bidders to buy US Treasury debt. These are:
- Bid-to-Cover Ratio
The bid-to-cover ratio is the total amount of bids divided by the total amount of Treasury debt offered for sale. A lower-than-usual bid-to-cover ratio suggests weaker demand.
Current Trends: The bid-to-cover ratio for 10-year Treasury notes has remained stable over the past several years, indicating steady demand. For example, the ratio was 2.51 in a February 2024 auction, which is about the median since 2013. - Primary Dealer Participation
Primary dealers are obligated to bid in all Treasury auctions and act as bidders of last resort. An unusually large share taken by primary dealers can indicate weaker demand from other investors.
Current Trends: The share of auction awards going to primary dealers has been falling. For example, in a July 2024 auction of two-year Treasury notes, primary dealers took only 9% of the $69 billion offering, a record low. - Foreign Participation
Foreign central banks have been buying more Treasury debt in dollar terms, but their percentage share has been falling over the last decade as the U.S. has borrowed more. When the Fed and foreign central banks cut back on purchases, the Treasury relies more on interest-rate-sensitive investors, likely raising the interest rate it has to pay.
In the past few years, there have been a few disruptions to the Treasury market—unusual volatility or a sudden spike in yields—that suggest that at times of stress, the market may not be as liquid as it once was. In March 2020, at the onset of the pandemic, so many institutional investors wanted to raise cash by selling Treasuries that the Fed bought $1 trillion in Treasuries over three weeks “to restore normal market functioning.” Such episodes underscore that the stock of U.S. Treasuries outstanding is growing faster, while the capacity of banks and dealers to serve as middlemen has been shrinking …
How to tell if the US Treasury is having trouble borrowing in the bond market
By: David Wessel – Brookings
