Supply Elasticity of U.S. Treasury Yields: An Empirical Analysis

Abstract

This paper assesses the sensitivity of U.S. Treasury yields to supply shocks that may be triggered by massive sell-offs of U.S. Treasuries. A VAR model is estimated to analyze the supply elasticity of U.S. Treasury yields over the 2000-2008 period. The results suggest that China has the potential, by virtue of its massive holdings of U.S. Treasuries, to moderately affect the Treasury yields. If China decided to sell off about 42% (or roughly $485 billion) of its Treasury holdings, that will raise the 6-month and 1-year yield by about 10 and 7 basis points, respectively. The estimated results also suggest that once the Treasury yields are pushed up by supply shocks, it will take about 3 years for interest rates to return to their pre-shock levels. Since domestic interest rates move in tandem with Treasury yields, an external supply shock has the potential to drive up interest rates and adversely affect the growth of employment and output in the economy.