Accommodative policy drives global bond fund risk-taking

Using granular security-level data from over 5,000 bond funds in the US and euro area, the study identifies a market-based risk-taking channel of monetary policy transmission.

Researchers found that accommodative monetary policies by both the Fed and the ECB are associated with increased credit risk and maturity structure risk in bond funds' portfolios.

This risk-taking is more pronounced for funds holding longer-term assets.

Unconventional monetary policy exerts stronger market-based risk-taking effects than conventional interest rate policy.

A one-percentage-point reduction in the Fed's shadow rate leads to a decline in the average credit rating of fund portfolios, with a 0.6 notch fall for 10-year bond portfolios.

While the ECB's effects are qualitatively similar, they are smaller in magnitude.

The findings also underscore the dominant role of US monetary policy, as Fed easing increases risk-taking in both US-domiciled and euro-area funds, whereas ECB policy has more muted cross-border effects.

The paper is motivated by the growing importance of non-bank financial intermediaries (NBFIs) in global financial markets, which have seen a structural shift towards market-based financing since the global financial crisis.

NBFIs in G20 countries held USD 196 trillion in assets in 2023, surpassing banks' total assets.

Investment funds, including bond funds, represent over 70 percent of the NBFI sector.

The study yields three key policy implications.

First, the stronger cross-border transmission of Fed shocks reflects the structural composition of euro-area bond funds, which hold a higher proportion of US securities due to scarce domestic safe assets.

This highlights the vulnerability of euro-area financial markets to external shocks and suggests that increasing the supply of European safe assets could strengthen ECB policy transmission.