The contribution of US bond demand to the US bond yield conundrum

What is it about?

Although the federal funds rate started rising from mid-2004 USlong term rates continued to fall. A likely contributory factor tothis ‘conundrum’ was the contemporaneous increase in US bond demand. Using ARDL based models, which accommodate structural breaks, this paper estimates the impact of foreign and domestic demand on AAA rated US bond yields in the ‘conundrum’ period. This impact is shown to have been everywhere significantly negative.

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Why is it important?

The fact that our model fully explains the ‘bond yield conundrum’ gives support to the hypothesis that the US CDO market was rapidly expanded before 2007 chiefly to absorb the overspill of global demand for safe assets. Moreover, our models demon strate that there are strong linkages between the 10-year Treasury yield and the long term yields of AAA rated non-Treasury bonds.