Emerging economies are no longer as vulnerable to US monetary policy as they once were

The latest monetary tightening in the United States between March 2022 and July 2023 resulted in much larger outflows of portfolio investments by non-residents than during the previous tightening (2016-2018) and the famous taper tantrum of 2013. However, emerging economies are less vulnerable to monetary tightening across the Atlantic than they were a decade ago. On the one hand, the impact of "flight to quality" capital movements by non-resident private investors on risk premiums and local currency bond yields is less significant. Secondly, the level and structure of corporate debt have improved.

In August 2021, an economist at the Federal Reserve Bank of Dallas published an article with the eye-catching title "Don't Look to the 2013 Tantrum for the Effect of Tapering on Emerging Markets", which he concluded by stating that the announcement of the Fed's reduction in monetary support in May 2013 (known by the highly exaggerated name of "taper tantrum") and the sharp rise in US bond yields that followed could not be taken as a reference to assess the effect of US monetary policy on emerging economies. This argument was based mainly on the observation that between 2013 and 2021, most central banks in the 13 leading emerging economies had rebuilt their foreign exchange reserves. Furthermore, for countries whose reserves exceeded the threshold of 7% of short-term external liabilities, the depreciation of the exchange rate against the US dollar was less pronounced and the rise in risk premiums on corporate external debt was much more limited. The more recent experience of US monetary tightening between March 2022 and July 2023 provides further insight into this analysis.

Massive portfolio investment outflows in 2022

In the five months following the Fed's first rate hike on 17 March 2022, there were massive outflows of portfolio investments by non-residents (nearly USD 60 billion in total). By comparison, during the taper tantrum and the subsequent period of monetary tightening (2016-2018), outflows were significantly lower (around 25 billion in both cases). Above all, they were wiped out very quickly (after only four months, compared with 14 months for the 2022-2023 episode).

The size of the outflows during the latest rate hike can be explained by the fact that the Fed raised its key rate more quickly and more sharply than in 2016-2018. In addition, the resulting rise in US bond yields was more significant (twice as high as in 2016-2018 and three times higher than during the brief period of tension following the tapering announcement). Nevertheless, emerging financial markets remain highly exposed to flight-to-quality capital movements.

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