The European Central Bank published an ECB Blog post presenting Young Economist Prize-winning research on portfolio rebalancing in international bond markets when returns on safe assets fall. The analysis finds that declining US Treasury returns tend to push investors into riskier assets with global reach, while falling German Bund returns mainly lead to shifts into other euro area sovereign bonds, with both effects smaller during periods of financial market stress. The study estimates “own demand elasticities” and “substitution elasticities” using portfolio data for more than 11,000 mutual funds in the euro area and the United States from 2007 to 2020, and identifies return shocks using US Federal Reserve and ECB monetary policy announcements that affect long versus short maturities. Demand for safe assets is less elastic than for riskier bonds, implying larger return declines are needed to induce investors to reduce Treasury or Bund holdings. When Treasury returns fall, funds increase exposures to riskier US dollar-denominated bonds such as supranational and US corporate issuance and to emerging market sovereign bonds, including in Latin America. When Bund returns fall, substitution is concentrated within the euro area sovereign market and spillovers outside the euro area are limited, with overall rebalancing around a tenth of that associated with Treasury return changes. During crises, substitution away from safe assets falls further, including a halving of rebalancing from Treasuries into US corporate bonds in 2008-09 and reduced substitutability between Bunds and other euro area government bonds from 2010 onward, consistent with increased fragmentation; the post notes this has implications for the composition of central bank asset purchase programmes in stressed markets. Applications for the European Central Bank’s 2025 Young Economist Prize will be open from 13 January to 12 February 2025.
European Central Bank 2025-01-06
European Central Bank blog research finds Treasury yield shocks spill globally while Bund rebalancing stays regional and weakens in market stress
The European Central Bank published research from the Young Economist Prize on portfolio rebalancing in international bond markets when returns on safe assets decline. The study finds that falling US Treasury returns push investors towards riskier global assets, while declining German Bund returns lead to shifts within euro area sovereign bonds, with both effects diminished during financial stress. The analysis highlights implications for central bank asset purchase programs in stressed markets.