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Fed wields strong influence on global financial conditions: Research

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JACKSON HOLE, WYOMING: The US Federal Reserve's influence on economic conditions beyond US borders may be bigger than it thinks, according to research 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 US dollar and Treasury bonds.

The research uses data on demand for Treasuries that would seem to refute Fed chair Jerome Powell's 2018 statement that "the role of US 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, it 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 US monetary policy to the rest of the world," the paper said, citing Mr 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 US government bonds and raising the value of the dollar, according to the paper's authors, Professors Arvind Krishnamurthy and Hanno Lustig at Stanford University.


Strong desire to buy US assets to seek shelter from an uncertain world has been a key theme this year.

The US-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 per cent.

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 at the Fed retreat said the dollar's dominance increases risks to the rest of the world and central banks might need to join together to create their own replacement reserve currency.

While strong interest in Treasuries helps the US 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, the two professors wrote. Fed officials have also warned about record-high US 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 the two finance experts.

They said a dependence on US assets exposes those countries to risks that they cannot repay their debts if dollar-based assets are in short supply.