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Fed Policy Expectations and Portfolio Flows to Emerging Markets

Koepke, Robin (2014): Fed Policy Expectations and Portfolio Flows to Emerging Markets.

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The empirical literature has long established that U.S. interest rates are an important driver of international portfolio flows, with lower rates “pushing” capital to emerging markets. On the basis of this literature, it is often argued that the Federal Reserve’s imminent policy tightening cycle is likely to weigh on portfolio flows to emerging markets in coming years. The analysis presented in this paper offers a different interpretation of the literature, suggesting that it is the surprise element of monetary policy that affects EM portfolio inflows. A shift in market expectations towards easier future U.S. monetary policy leads to greater foreign portfolio inflows and vice versa. Given current market expectations of sustained increases in the federal funds rate in coming years, EM portfolio flows could be boosted by a slower pace of Fed tightening than currently expected or could be reduced by a faster pace of Fed tightening.

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