We first examine asset price returns over a one to three-day window after the FOMC announcements, but consider longer windows later in extensions. Our first set of results is in Table 1, which shows that the US monetary policy has a significant effect across asset classes in emerging economies. A surprise policy tightening in the US results in exchange rate deprecation, decline in equity prices, and increase in sovereign yields in emerging economies. Specifically, a 10 percent increase in Treasury yield results in a nearly 0.5 percent exchange rate depreciation, 1 percent decline in equity prices, and 1 percent increase in sovereign yields of emerging economies.<sup>15</sup> The impact persists for all three days considered in the analysis. The effect on exchange rates is similar in one to three days after the policy announcement, while the impact on equity prices and bond yields increases in days after the announcements.

**Table 1: The Effect of the surprise US Monetary policy on Emerging Economies’ Financial Variables**

||E<br>k=1|xchange rates<br>k=2|<br>k=3|k=1|Equity prices<br>k=2|k=3|k=1|Bond yields<br>k=2|k=3|
|---|---|---|---|---|---|---|---|---|---|
|2yr Treasury yield|0.044***|0.048***|0.047***|-0.061***|-0.094***|-0.101***|0.072***|0.094***|0.097***|
||[7.00]|[7.25]|[8.74]|[-8.02]|[-10.90]|[-10.27]|[4.66]|[6.57]|[6.13]|
|Constant|-0.042***|-0.007|-0.009|0.313***|0.330***|0.456***|-0.111***|-0.133***|-0.101***|
||[-5.04]|[-0.78]|[-1.32]|[32.77]|[29.69]|[36.50]|[-6.17]|[-7.31]|[-5.12]|
|Observations|1,300|1,300|1,300|1,194|1,200|1,197|1,049|1,052|1,053|
|R-squared|0.087|0.076|0.064|0.047|0.067|0.068|0.051|0.061|0.057|
|# of countries|20|20|20|19|19|19|17|17|17|

_Notes:_ Dependent variables are percent change in exchange rate, equity prices, or bond yields, between the day of FOMC announcements and k days after that, as per Equation 1. The independent variable is percent change in 2-year Treasury yield between t and t-1, t being the day of the FOMC announcements. Regressions include country fixed effects. Robust t statistics are in parentheses. *, **, *** indicate that the coefficients are significant at 10, 5, and 1 percent level.

There are two channels whereby changes in Treasury yields could affect capital flows and asset prices in emerging economies. As per the portfolio balance channel, investors in search of higher yield buy foreign assets when Treasury yields decline (and vice versa); and as per the signaling channel a decline in Treasury yields implies a decline in the risk-neutral component of bond yields, widening the interest rate differentials with respect to emerging market economies, and thus triggering carry trades and capital flows into emerging market economies. The approach used here does not distinguish between the channels whereby the spillover occurs—i.e. the portfolio balance channel or the signaling channel. In our view, decomposing the impact into various channels is not necessarily of interest from the emerging market perspective.

> 15 Or a one standard deviation increase in Treasury yields on FOMC days results in about a 0.4 percent exchange rate depreciation, 0.6 percent decline in equity prices, and 0.7 percent increase in sovereign yields of emerging economies.

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