## Fed Tightening May Squeeze Portfolio Flows to Emerging Markets

_IMF Blog, December 14, 2017_

## Source details

**Canonical URL:** [Fed Tightening May Squeeze Portfolio Flows to Emerging Markets](https://www.imf.org/en/blogs/articles/2017/12/14/fed-tightening-may-squeeze-portfolio-flows-to-emerging-markets)

## Other formats

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## Bibliographic details
- Authors: Robin Koepke
- Published: December 14, 2017

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### Overview and context
- Author: Robin Koepke
- Publication date: December 14, 2017
- Topic: Impact of US Federal Reserve monetary policy normalization on portfolio flows to emerging markets (foreign purchases of emerging market stocks and bonds).
- Source analysis basis: IMF’s new model and the IMF’s latest Global Financial Stability Report; econometric model adapted from a 2014 paper.

### Key findings from the IMF model
- Normalization—raising the policy interest rate and shrinking the balance sheet—will likely reduce portfolio inflows by about $70 billion over the next two years, compared with average annual inflows of $240 billion since 2010.
- Shrinkage in the Fed’s $4.5 trillion balance sheet, which began in October, accounts for most of the impact on portfolio flows.
- Since 2010, about $260 billion in portfolio inflows resulted from the “push” of unconventional Fed monetary policy rather than domestic “pull” factors.
  - Of that $260 billion, $170 billion is attributed to the Fed’s large scale asset purchases as investors rebalanced toward higher-yielding emerging market assets.
  - Downward shifts in market expectations for future Fed policy rates accounted for $90 billion.
- Model projections:
  - Reduction in the size of the Fed’s balance sheet will cut flows by $55 billion over the next two years.
  - Additional rise in short-term interest rates in line with IMF forecasts could reduce flows by an additional $15 billion.
  - Assumes the US policy rate will rise to just under 3 percent by the end of 2019, and that tightening will be orderly and will not take a toll on emerging market growth.

### Risks and historical precedent
- Even limited withdrawals of foreign capital, if concentrated over a short period, could create significant stress for emerging market borrowers.
- Example: During the “taper tantrum” in 2013, when markets interpreted Fed communication as signaling an accelerated reduction in asset purchases, some $40 billion flowed out of emerging markets over a period of seven weeks as exchange rates depreciated sharply and asset prices declined.

### Policy implications and recommendations
- A gradual pace of normalization is crucial to allow emerging markets to adjust to reduced inflows of funds.
- The Fed and other advanced-economy central banks should:
  - Change policy gradually.
  - Provide well-communicated plans on unwinding their holdings of securities.
  - Provide guidance on any potential changes to their frameworks to ensure a smooth normalization process.

*Source: IMF blog post "Fed Tightening May Squeeze Portfolio Flows to Emerging Markets" by Robin Koepke, December 14, 2017.*

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- **121417r**
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## References

- [https://www.imf.org/wp-content/uploads/2017/12/BLOG-1024x600-Singapore-derivatives-traders-Caro-Rupert-Oberhaeuser-Newscom-carophotos361882.jpg](https://www.imf.org/wp-content/uploads/2017/12/BLOG-1024x600-Singapore-derivatives-traders-Caro-Rupert-Oberhaeuser-Newscom-carophotos361882.jpg)
- [https://www.imf.org/wp-content/uploads/2017/12/FED-Blog-Chart-1.jpg](https://www.imf.org/wp-content/uploads/2017/12/FED-Blog-Chart-1.jpg)
- [Global Financial Stability Report](https://www.imf.org/en/Publications/GFSR/Issues/2017/09/27/global-financial-stability-report-october-2017)
- [https://www.imf.org/wp-content/uploads/2017/12/FED-Blog-Chart-2.jpg](https://www.imf.org/wp-content/uploads/2017/12/FED-Blog-Chart-2.jpg)

_Source: https://www.imf.org/en/blogs/articles/2017/12/14/fed-tightening-may-squeeze-portfolio-flows-to-emerging-markets_