When is Bad News Good News? U.S. Monetary Policy, Macroeconomic News, and Financial Conditions in Emerging Markets

Abstract

Rises in U.S. interest rates are often thought to generate adverse spillovers to emerging market economies (EMEs). We show that what appears to be bad news for EMEs might actually be good news, or at least not-so-bad news, depending on the source of the rise in U.S. interest rates. We present evidence that higher U.S. interest rates stemming from stronger U.S. growth generate only modest spillovers, while those stemming from a more hawkish Fed policy stance or inflationary pressures can lead to significant tightening of EME financial conditions. Our identification of the sources of U.S. rate changes is based on high-frequency moves in U.S. Treasury yields and stock prices around FOMC announcements and U.S. employment report releases. We interpret positive comovements of stocks and interest rates around these events as growth shocks and negative comovements as monetary shocks, and estimate the effect of these shocks on emerging market asset prices. For economies with greater macroeconomic vulnerabilities, the difference between the impact of monetary and growth shocks is magnified. In fact, for EMEs with very low levels of vulnerability, a growth-driven rise in U.S. interest rates may even ease financial conditions in some markets.

Spillovers to Emerging Markets from US Economic News and Monetary Policy

“…However, for US employment news, it is not possible to distinguish statistically how much of its effect on long-term emerging market bond yields works through expectations of monetary policy. This finding clarifies that the result in Hoek et al (2020), in which US interest rates spill over to emerging market interest rates on days of US employment releases, may simply reflect employment news and therefore may have nothing to do with US monetary policy.…”

“…The vulnerability index is the average, across the six listed measures of vulnerability of the rank of each emerging market in the preceding year, followingHoek et al (2020).©International Monetary Fund. Not for Redistribution…”

A Study on How International Portfolio Investment Flows Affect Macrofinancial Risks and Control Channels

“…Te infow of equity securities on macrofnancial risk over the short term is 0.0040, while the infow over the long term is −0.0116. Te results of the impact of equity security outfows on macrofnancial risk are displayed in Column (2). Te macrofnancial risk is not signifcantly impacted by the short-term outfow of equity securities, but it is signifcantly impacted by the long-term outfow, which is −0.0081.…”

“…Column (2) shows the control efect of foreign exchange reserves on equity securities fow and macrofnancial risk, with EIF_1 of 0.0255 and EIF_1 of 0.003. Tis indicates that foreign exchange reserves can reduce the macrofnancial risk generated by equity securities fows to some extent but still cannot fully mitigate this risk.…”

“…Emerging economies have historically risen with the wave of industrialization through industrial transfer, aided by ample international capital liquidity. However, the Fed's persistent policy of increasing interest rates has resulted in a stronger US dollar and depreciating currencies in emerging economies [2]. When expectations of a decline in the short-term exchange rate rise, the willingness of cross-border capital to invest weakens further, and there is a sudden halt in capital infows or even capital fight, resulting in a cascade of asset price declines.…”