The Effects of U.S. Monetary Policy on International Mutual Fund Investment

Abstract

We study the effects of U.S. monetary policy on international mutual fund investment. We apply a novel variant of the shock identification procedure in Bu et al. (2021) to decompose observed U.S. monetary policy surprises into pure monetary policy shock and information shock components. We find that an increase in interest rates driven by a pure monetary policy shock leads to persistent outflows from EMs and to a lesser extent global and U.S. mutual funds. On the other hand, when rates increase following a positive information shock investors reallocate capital out of U.S. bonds and into (riskier) equity funds, both U.S. and abroad. We attribute these differences to the risk-taking channel of monetary policy. Pure monetary policy shocks tighten financial conditions, while information shocks lower the VIX. Finally, we explore regional heterogeneity in responses. Global EMs and Asia-focused funds suffer sharp outflows after tightening U.S. monetary policy shocks. Information shocks instead lead to large inflows to China-focused funds, reflecting the large economic ties between China and the U.S.