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The Coming U.S. Interest Rate Tightening Cycle: Smooth Sailing or Stormy Waters?

Carlos Arteta (), Ayhan Kose, Franziska Ohnsorge and Marc Stocker

No 100014, Policy Research Notes (PRNs) from The World Bank

Abstract: Since the global financial crisis, the policy accommodation by the U.S. Federal Reserve has helped support activity, bolstered asset valuations, and reduced risk premia. In addition, it has been instrumental in lowering long-term interest rates in the United States and other advanced economies. As investors search for higher yields, this policy accommodation has also contributed to an increase in capital inflows to emerging and frontier market economies (EFEs, roughly speaking, developing countries with either substantial or partial access to international capital markets). As a result, borrowing conditions in EFEs have remained particularly favorable. However, the timeframe of the tightening cycle remains uncertain and vulnerabilities in many EFEs have been rising especially over the past two years. The ‘taper tantrum’ episode of May-June 2013 is a painful reminder that even a long-anticipated change in Fed policies can surprise markets in its specifics, and lead to significant financial market volatility and disruptive movements in capital flows to EFEs. This episode was sparked by a statement that became known as ‘taper talk,’ when Fed Chairman Ben Bernanke mentioned the possibility of the Fed slowing its asset purchases ‘in the next few meetings’ on May 22, 2013 (Bernanke 2013b). While financial markets had expected such an action at some point in the future, they were surprised by the mention of an approximate timeframe.

Keywords: monetary policy; portfolio inflows; accounting; deposits; fixed income; long-term interest; international capital; real interest rates; global markets; interest; post-crisis ... See More + period; institutional investors; debt crisis; equity valuations; option; bond spreads; developing countries; banking systems; total debt; exporters; revenues; portfolio; fiscal policy; inflation risks; stock market index; instruments; market participants; market liquidity; labor market; bank asset; oil prices; bond investors; indebtedness; currency; foreign currency debt; reserve bank; exchange rates; bond issuance; primary dealers; government bond yields; currency depreciations; emerging market; debt; markets; financial crises; inflation rate; international debt; banking sectors; borrowing costs; interest rate risks; bank policy; current account deficits; market economies; foreign currency exposure; transactions; emerging markets; stock market volatility; federal reserve; bond markets; interest payments; long-term interest rate; bank market; market conditions; future; foreign direct investment; short-term external debt; long-term bond yields; equity funds; bank balance sheets; debt securities; issuance; global bond index; real exchange rate; local currency; monetary policies; securities; public debt; balance of payment; treasury; market intermediaries; private debt; federal reserve system; inflation rates; holdings; insurance; currencies; government debt; government bonds; open market; global trade; returns on equity; corporate bond; treasury bonds; financial risks; treasury yields; financial assets; international debt markets; portfolio investment; lending; capital flow; risk aversion; portfolio flows; labor markets; commodity prices; liabilities; market returns; international markets; emerging bond markets; investing; deficit; capital markets; basis points; liability; short-term interest rates; stock; fiscal deficits; asset prices; sovereign bond markets; interest rate; exchange; stock market; banking system; treasuries; international financial markets; liquidity; real interest; international capital markets; bond indexes; money market rates; cds; bonds; financial stress; macroeconomic conditions; global capital markets; non-performing loans; policy credibility; debt issuance; government bond; bond yields; reserve; central banks; inflation; pension; developing country; emerging market economies; credibility; credit default; bank lending; budget; central bank; international finance; push” factors; fiscal policies; bond index; credit worthiness; credit ratings; long- term debt; market-making; treasury yield; policy responses; bond yield; global bond market; trading; global capital; credit default swap; interest rates; options; sovereign bond; capital outflows; implied volatility; sovereign rating; nominal yields; return; deficits; basis point; direct investment; loans; reserves; inventories; gross domestic product; financial system; finance; foreign currency; debt holdings; debt levels; equity; credit expansion; investors; sovereign debt; valuations; global bond; federal reserve bank; long- term yields; financial stability; private sector credit; financial crisis; short- term debt; returns; market index; short-term debt; long-term interest rates; domestic banking; corporate bond issuance; long-term yields; bond market; contract; price stability; yield curve; expenditures; asset quality; capital flows; current account deficit; illiquid” markets; t-bill; balance sheet; default; market; credit rating; foreign exchange; debt markets; foreign currency exposures; currency depreciation; corporate debt; goods; investor; primary dealer; durable; financial market; stocks; investment; bond; sovereign bonds; share; balance sheets; financial markets; push factors; bond prices; bid; capital inflows; revenue; money market; external debt; credit growth; exchange rate; arbitrage; banking crises; hedge; swap; retail investors; external borrowing (search for similar items in EconPapers)
Pages: pages 71 pages
Date: 2015-09
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