The Federal Reserve Bank of New York works to promote sound and well-functioning financial systems and markets through its provision of industry and payment services, advancement of infrastructure reform in key markets and training and educational support to international institutions.
Jiakai Chen, Haoyang Liu, David Rubio, Asani Sarkar, and Zhaogang Song
In March 2020, as the COVID-19 pandemic disrupted a range of financial markets, the ability of dealers to maintain liquid conditions in these markets was questioned. Reflecting these concerns, authorities took numerous steps, including providing regulatory relief to dealers. In this post, we examine liquidity provision by dealers in several financial markets during the pandemic: how much was provided, possible causes of any shortfalls, and the effects of the Federal Reserve’s actions.
Richard K. Crump, Nikolay Gospodinov, and Desi Volker
Breakeven inflation, defined as the difference in the yield of a nominal Treasury security and a Treasury Inflation-Protected Security (TIPS) of the same maturity, is closely watched by market participants and policymakers alike. Breakeven inflation rates provide a signal about the expected path of inflation as perceived by market participants although they are also affected by risk and liquidity premia. In this post, we scrutinize the dynamics of breakeven inflation, highlighting some intriguing behavior which has persisted for a number of years and even through the pandemic. In particular, we document a substantial downward shift in the level of breakeven inflation as well as a marked flattening of the breakeven inflation curve.
Jennifer Gennaro, Jason Healey, Anna Kovner, Michael Lee, and Patricia Mosser
The Federal Reserve Bank of New York partnered with Columbia University’s School of International and Public Affairs (SIPA) for the second annual State-of-the-Field Conference on Cyber Risk to Financial Stability on December 14-15, 2020. Hosted virtually due to the COVID-19 pandemic, the conference took place amidst the unfolding news of a cyberattack against a major cybersecurity vendor and software vendor, underscoring vulnerabilities from cyber risk.
Adam Copeland, R. Jay Kahn, Antoine Martin, Matthew McCormick, William Riordan, Kevin Clark, and Tim Wessel
The Treasury repo market is at the center of the U.S. financial system, serving as a source of secured funding as well as providing liquidity for Treasuries in the secondary market. Recently, results published by the Bank for International Settlements (BIS) raised concerns that the repo market may be dominated by as few as four banks. In this post, we show that the secured funding portion of the repo market is competitive by demonstrating that trading is not concentrated overall and explaining how the pricing of inter-dealer repo trades is available to a wide range of market participants. By extension, rate-indexes based on repo trades, such as SOFR, reflect a deep market with a broad set of participants.
The Main Street Lending Program was the last of the facilities launched by the Fed and Treasury to support the flow of credit during the COVID-19 pandemic. The others primarily targeted Wall Street borrowers; Main Street was for smaller firms that rely more on banks for credit. It was a complicated program that worked by purchasing loans and sharing risk with lenders. Despite its delayed launch, Main Street purchased more debt than any other facility and was accelerating when it closed in January 2021. This post first locates Main Street in the constellation of COVID-19 credit programs, then looks in detail at its design and usage with an eye toward any future programs.
Investors can buy volatility hedges on the stock market using variance swaps or VIX futures. One motivation for hedging volatility is its negative relationship with the stock market. When volatility increases, stock returns tend to decline contemporaneously, a result known as the leverage effect. In this post, we measure the cost of volatility hedging by decomposing the prices of variance swaps and VIX futures into volatility forecasts and estimates of expected returns (“equity volatility term premia”) from January 1996 to June 2020.
Can option traders take a square root? Surprisingly, maybe not. This post shows that VIX futures prices exhibit significant deviations from their option-implied upper bounds—the square root of variance swap forward rates—thus violating the law of one price, a fundamental concept in economics and finance. The deviations widen during periods of market stress and predict the returns of VIX futures. Just as the stock market struggles with multiplication, the equity volatility market appears unable to take a square root at times.
The recent era of globalization has witnessed growing cross-country trade integration as firms’ production chains have spread across the world, and with stock market returns becoming more correlated across countries. While research has predominantly focused on how financial integration impacts the propagation of shocks across international financial markets, trade also influences these cross-border spillovers. In particular, one important aspect, highlighted by the recent work of di Giovanni and Hale (2020), is how the global production network influences the transmission of U.S. monetary policy to world stock markets.
“U.S. stocks are racing toward a second consecutive quarter of dramatic gains, continuing a historic stock-market recovery that few predicted in the depths of the March downturn,” said a September Wall Street Journal article. “The stock market is detached from economic reality. A reckoning is coming,” said the Washington Post. What is going on? In this post, I look not at what stocks have actually done or will do, but at what investors expected should have happened, and what they expect will happen going forward. It turns out that, at least by the particular measure of expectations I consider, investors expected stock returns to be high all along and continue to expect the same in the future.
When the U.S. Treasury sells a new security, the security is announced to the public, auctioned a number of days later, and then issued sometime after that. When-issued (WI) trading refers to trading of the new security after the announcement but before issuance. Such trading promotes price discovery, which may reduce uncertainty at auction, potentially lowering government borrowing costs. Despite the importance of WI trading, and the advent of Treasury trading volume statistics from the Financial Industry Regulatory Authority (FINRA), little is known publicly about the level of WI activity. In this post, we address this gap by analyzing WI transactions recorded in FINRA’s Trade Reporting and Compliance Engine (TRACE) database.
Liberty Street Economics features insight and analysis from New York Fed economists working at the intersection of research and policy. Launched in 2011, the blog takes its name from the Bank’s headquarters at 33 Liberty Street in Manhattan’s Financial District.
The editors are Michael Fleming, Andrew Haughwout, Thomas Klitgaard, and Asani Sarkar, all economists in the Bank’s Research Group.
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