Taper Tantrums: Quantitative Easing, Its Aftermath, and Emerging Market Capital Flows

Abstract

<jats:title>Abstract</jats:title> <jats:p>This paper examines the spillover effects of U.S. unconventional monetary policy (UMP) on emerging market capital flows and asset prices. Affine term structure model estimates show that U.S. monetary policy shocks, identified with high-frequency Treasury futures data, represent revisions to expected short-term yields and term premia, especially during the UMP period. The policy shocks exhibit sizable effects on U.S. holdings of emerging market assets. These effects disproportionately manifest through valuation changes versus physical flows, are more pronounced for equity relative to bond markets, and are asymmetric between the quantitative easing and tapering periods, with flows more important during the unwinding.</jats:p>

The Financial Market Effects of Unwinding the Federal Reserve’s Balance Sheet

“…Chari, Dilts-Stedman and Lundblad (2020) present evidence generally consistent with this as they find that money flowed from emerging market countries into the U.S. when the Federal Reserve tapered its pace of asset purchases.…”

In search of distress risk in emerging markets

“…The dataset is novel in its broad coverage of balance sheet variables and, especially, of default events in emerging markets. 19 As Table 1 shows, the CRI database contains information on firms' bankruptcies and other corporate default actions. This is important because countries differ in their definitions of default.…”

“…Rising US interest rates, shortfalls in global liquidity, and foreign investor risk appetite can increase the cost of borrowing and hamper the ability of firms in emerging markets to repay their debts. Evidence suggests that tightening U.S. monetary policy shocks are correlated with increasing bond yields and lower equity prices in emerging markets (Chari et al, 2020), which in turn increase financing costs (Bruno and Shin (2015 a,b)). Through asset price and exchange rate changes, financial shocks can affect collateral values, the borrowing capacity of firms, and corporate default probabilities.…”

“…To fix ideas, consider the following. Chari et al (2020) disentangle the channels through which U.S. monetary policy shocks can alter expectations hypothesis-driven yields and risk premia in the term structure of U.S. interest rates. Via portfolio rebalancing and signaling, changes in domestic yields and risk premia can have a significant impact on equity prices and bond yields in emerging markets.…”

Unconventional monetary policy and international equity capital flows to emerging markets

“…The majority of the existing literature is centred on Fed monetary policy (e.g., Chari et al, 2020;Dahlhaus & Vasishtha, 2020;Gamboa-Estrada, 2020;Koepke, 2018), whereas evidence from other major central banks is limited despite their important role in the global financial cycle (Chari et al, 2020;Dilts-Stedman, 2019;Fratzscher et al, 2016). We fill this gap by analyzing the impact of monetary policies of two other major central banks in addition to Fed, namely, the European Central Bank (ECB) and the Bank of Japan (BoJ).…”