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CFA Institute Journal Review summarizes "Channels of US Monetary Policy Spillovers to International Bond Markets," by E. Albagli, L. Ceballos, S. Claro, and D. Romero, published in the Journal of Financial Economics, November 2019.


Changes in US monetary policy around Federal Open Market Committee meetings have a spillover effect into international bond markets, which has become more pronounced since the 2008 global financial crisis. The effect differs between developed and emerging economies: Emerging economies tend to intervene in the foreign exchange market, whereas developed economies tend to let the exchange rate adjust without intervention.

What Is the Investment Issue?

The authors investigate how US monetary policy, as implemented by the Federal Reserve during Federal Open Market Committee (FOMC) meetings, affects international bond markets. Using separate samples of developed and emerging economies, the authors investigate differences between these markets in the effects of and responses to US monetary policy.

How Did the Authors Conduct This Research?

The authors follow an event study methodology using the two-day event window around an FOMC meeting to identify monetary policy shocks. A key variable is the change of the two-year US Treasury yield (the yield at the close of the day after the FOMC meeting less the yield at the close of the day before the meeting). This measure is one of several independent variables used to assess changes in the dependent variable of the change in the bond yield over the same two days surrounding the FOMC meeting. Separate regressions are performed using a dependent variable that differs based on location (12 developed economies and 12 emerging economies) and bond maturity. The data sample, which runs from 2003 through 2016, is split into two periods—January 2003 to October 2008 and November 2008 to December 2016—to investigate any differences after the financial crisis.

What Are the Findings and Implications for Investors and Investment Professionals?

The authors find that a spillover effect, present during the entire period, became more pronounced after the financial crisis. Further, the effect differs between developing and emerging economies. Separating a bond yield into a risk-neutral component based on expected future short-term rates and a term premium component (the yield based on a risk factor model less the risk-neutral component), the authors find that the spillover effect is concentrated in the risk-neutral component of yields for developed economies—the opposite of what they find in emerging economies. Regarding impact, the spillover effects are similar in size to effects caused by other monetary policy or macroeconomic news releases.

The authors suggest that central banks face a trade-off between allowing interest rate differentials to change or allowing the exchange rate to adjust when reacting to US monetary policy changes. Emerging economies choose to intervene in the foreign exchange market, resulting in more-pronounced effects in the term premium component of bond yields. Developed economies allow the exchange rate to adjust without intervention, resulting in more-pronounced effects in the risk-neutral component of bond yields.

These differences in policy actions around US monetary policy changes are of interest to market participants in both the bond market and the foreign exchange market. Although the authors do not explore how market participants can exploit these policy reactions, simply knowing what policies to expect from developed and emerging economies has value.

About the Author

Thomas M. Arnold CFA