Tracking Spillovers During the Taper Tantrum : Evidence from Institutional Investor Transactions in Emerging Markets

In this report, we study the mid-2013 taper tantrum—a market event comprised of a series of policy communications from the Federal Reserve that contributed to sharp volatility across global asset prices—as a case study to shed light on a widely-referenced monetary policy shock. Our research documents and analyzes the trading activity of institutional investors to provide policymakers and researchers with a picture of the interplay between market price movements and investor behavior. The work is motivated by the growing importance of unconventional monetary policy and the role of the market participants in transmitting such signals across markets. We use proprietary data that includes global financial markets transactions (foreign exchange and government bond trades) executed by all types of institutional investors, made available by the Markets Division of J.P. Morgan's Corporate & Investment Bank. We find that flows of institutional investors have substantial explanatory power for EM currency performance. In particular, the extent of EM currency depreciation during the taper tantrum is correlated with the trading activity of a relatively small set of hedge funds and banks associated with momentum, as well as asset managers that do not typically exhibit systematic behavior. During the taper tantrum, asset manager net flows became increasingly correlated with changes in EM currencies and the net flows of certain banks and hedge funds, reflecting potential herding behavior that had a significant impact on prices. We also find evidence of a time-varying relationship between net flows and EM currency price action consistent with a larger impact of net flows amid the rise in market volatility over the period. Our findings illustrate how private investor trading activity can be an important, but difficult-to-predict, component in monetary policy transmission mechanism. Central banks should continue to advance their understanding of how policy measures designed to influence market prices also affect the behavior of market participants