Flights-to-quality from EM Bonds to safe-haven US Treasury Securities: A time-frequency Analysis

ABSTRACT

We study 2001–2020 flight-to-quality episodes encompassing two planetary-scale crises: the Global Financial Crisis (GFC) of 2007–2008 and the coronavirus-triggered global meltdown. We focus on time-frequency lead-lag nexuses between holding emerging market (EM) debt and investing in relatively risk-free US Treasuries. Wavelet coherency along with the phase-difference approach is used. Our results reveal varying lead-lag patterns and low-coherence zones between EM bonds and US Treasuries, which imply the existence of appealing diversification attributes. The flights-to-quality during the crisis periods, such as the GFC and COVID-19 pandemic, emphasize the safe-haven characteristics of US Treasures. They also evidence that the post-Covid tightening of credit spreads to the pre-crisis levels is faster than the post-GFC recovery. We demonstrate that for EM debt investors, the US Treasury market allows for dynamic risk mitigation strategies during both global crises.

KEYWORDS:

• subprime and Covid-19 crises
• flight-to-quality
• spread and total return
• safe-haven US Treasuries
• emerging market debt

Highlights

We examine the flight-to-quality (FTQ) from emerging market (EM) bonds to safe-haven US Treasuries.

Wavelet coherency along with the phase-difference approach is used to identify FtQ episodes.

We observe FtQs through regime switching between risk-on/risk-off attitudes relative to EM debt.

Compared to the Global Financial Crisis and the pandemic, EM spreads recover faster from the latter.

For EM debt investors, the US Treasury market allows for dynamic risk mitigation strategies.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Additional information

Funding

The first author thankfully acknowledges the financial support by FCT, I.P., the Portuguese national funding agency for science, research and technology, under the Project UIDB/04521/2020. The article was prepared within the framework of the Basic Research Program at HSE University. This research is partly funded by Institute of Business Research, University of Economics Ho Chi Minh City, Ho Chi Minh City, Vietnam.