Safe Asset Shortages and the Nominal Term Structure of U.S. Interest Rates

Abstract

I use an affine term structure model with unspanned macro variables to investigate the importance of high Chinese growth before the financial crisis and low Chinese growth following the crisis for the U.S. long-term nominal interest rates. Before the financial crisis, a higher Chinese nominal growth increases Chinese foreign reserves, mainly in the form of the U.S. Treasuries, and decreases the estimated five-year Treasury yield by signaling the lower expectations of the U.S. nominal short rate. The effect of the Chinese nominal growth on the U.S. nominal term structure is the sum of the effects of the Chinese leading indicator and inflation. These empirical findings are important to understand the secular decline of long-term nominal interest rates in the U.S. before the financial crisis. After the financial crisis, the lower Chinese real growth lowers the estimated five-year Treasury yield mainly by lowering the estimated five-year Treasury term premium and to a lesser extent by signaling the lower U.S. future nominal short rate. I measure the effect of the Chinese real growth on the U.S. nominal term structure with the Chinese leading indicator after I control for the inflation. Lower Chinese real growth contributes to understanding the unusually low long-term nominal interest rates in the U.S. after the financial crisis.