The European Central Bank published a Working Paper analysing whether bond funds transmit monetary policy through a market-based risk-taking channel, using security-level holdings data for more than 5,000 bond funds domiciled in the United States and the euro area. The paper finds that accommodative monetary policy by both the Federal Reserve and the ECB is associated with bond funds shifting toward riskier portfolios, with the effect stronger for longer-maturity holdings and more pronounced for unconventional monetary policy than for interest-rate policy; it also finds that Fed policy has a larger impact on funds’ risk-taking than ECB policy, including spillovers to euro-area funds. The paper notes that the views expressed are those of the authors and do not necessarily reflect those of the ECB. Risk-taking is measured as each fund’s weighted-average credit rating, constructed from holdings-level ratings and weighted using book values to better isolate active rebalancing from price effects. Monetary policy is proxied using Wu and Xia shadow rates and decomposed into conventional and unconventional components, with identification based on instrumental-variable methods using Jarocinski and Karadi “pure” monetary policy shocks, alongside robustness checks using a dynamic panel approach. In magnitude, a one percentage point reduction in the Fed’s shadow rate is associated with a deterioration in average portfolio credit quality, and the paper estimates that the roughly six percentage point decline in the Fed’s shadow rate between 2019 and 2022 implies about a 0.45-notch decline in the weighted-average credit rating, rising to about 0.6 of a notch for portfolios of 10-year bonds; results for the ECB are qualitatively similar but smaller. Effects are reported as broader-based but stronger for active and institutional funds and for funds with longer-duration portfolios.
European Central Bank 2026-02-26
European Central Bank working paper links monetary easing to higher bond fund risk-taking with stronger effects from unconventional tools and US policy
The European Central Bank's Working Paper examines how bond funds transmit monetary policy through a market-based risk-taking channel, using data from over 5,000 bond funds in the U.S. and euro area. It finds that accommodative monetary policy by the Federal Reserve and ECB leads bond funds to adopt riskier portfolios, with a stronger effect from the Fed and more pronounced for unconventional policy. The analysis uses shadow rates and instrumental-variable methods, noting a significant impact on credit quality, particularly for longer-duration portfolios.