US Watch – Crossing borders: where is the QE money?

by: Maritza Cabezas

US Watch - 16 December 2014 - Crossing borders: where is the QE money?.pdf ()
  • After five years of low interest rates, US investors are increasingly showing more preference for relatively safe assets in their search for yield. High-rated governments and financial institutions have benefitted the most.
  • Indeed, since the first round of asset purchases or quantitative easing (QE) in 2008, US investors have been gradually shifting to high-yield assets originating from Canada and Australia. It is even the case that there is some concentration of capital flows to bonds issued by these countries.
  • Meanwhile, the value of US holdings in emerging markets as a share of total foreign holdings has increased recently, mainly showing a preference for higher yielding bonds, but with high credit ratings.
  • From a sector perspective, after financial and governments, the energy sector has benefitted the most from US capital flows in this period. There has already been a correction in this sector given the sharp drop in oil prices.

US monetary easing and risk appetite

Now that the US economy is leading the global recovery and is preparing to shift towards monetary policy normalisation, the discussion is centred on the implications of policy normalisation for countries that benefitted from the search for yield and the low interest rate environment in the US. Since the financial crisis, the Fed has pursued a highly accommodative monetary policy with low interest rates and raising the asset side of the Fed’s balance sheet to over USD 4.48 trillion from nearly USD 1 trillion at the end of 2008. The asset purchase programme was finally brought to an end in October 2014 and Fed officials are now discussing the conditions for a rate hike.


That said, more than five years of accommodative monetary policy have had an impact on US investors’ risk appetite. This had important international spillover effects on asset prices and global investment flows. Announcements associated with the Fed’s asset purchase programmes were followed by a rapid increase in US investors’ holdings of foreign equity securities and foreign debt. The greatest response was recorded after the initial QE programme in 2008, but subsequent rounds also had an impact, albeit on a more modest scale. Although it is difficult to determine the direct impact of QE on capital flows, US investments in the foreign equity markets more than doubled over the past five years, with only 20% attributable to price increases. The strong demand for equities for some is not only attributable to QE, but also to the improvement in corporate profits that has accompanied the process.

Advanced economies more attractive to US investors

The geographical distribution of US cross-border investments shows that the United Kingdom is a main destination, followed by Cayman Islands, Canada, Japan and Australia. Since the start of QE, the fastest growth of US investments in foreign holdings has been recorded in Canada, Australia, Ireland and the Netherlands. The US investments in emerging markets as a share of total investments remain relatively low and have been somewhat volatile in the past five years.


From a flow perspective, the most recent data show that Asia has had the strongest growth, with Eastern Europe and Latin America declining. It should be mentioned that capital flows to emerging markets are somewhat understated, since the data collected are based on residence. This means that emerging markets that issued debt securities through foreign subsidiaries in Ireland or the Netherlands, for instance, are not included in emerging markets.

Moreover, it is important to recognise that portfolio reallocations that seem relatively small for US investors are large from the perspective of emerging markets receiving capital flows. Even small changes in US holdings can generate large asset prices responses, as was the case during the tapering event in the summer of 2013. Where emerging markets are concerned, Malaysia, Peru and Poland posted the strongest growth in terms of market capitalisation.

US investors and their choice of assets

As mentioned, from a portfolio allocation perspective, US investors generally have a strong preference for equities. A total of 70% of cross border investments are in equities. The US is the only country that holds more foreign equities than foreign debt. The Netherlands is second, holding 46% of its foreign investments in equities. We see that this preference has increased after the asset purchase programmes, when we take away the price effect. Investments in foreign equities amount now to 20% of total US investments.

According to the BIS, there are many equity markets in which the expected payoff from dividends exceeded the real yields on longer-dated high-quality bonds, making it more attractive for market participants to extend their search for yield beyond fixed-income markets. Stocks paying high and stable dividends were seen as particularly attractive and posted large gains.


But the search for yield was not the only motivation driving investors. In view of regulatory requirements, there has been an increasing preference for high-grade relatively safe assets that are more liquid. Where the largest shifts have been made is in debt securities. Data suggest that investors have been shifting their foreign financial sector bonds and government bonds to instruments with higher credit ratings. Currently US investments in cross-border corporate bonds amount to 20% of total corporate bond holdings, but this ratio has doubled since 2009.

Moreover, if we compare the relationship between holdings of domestic government bonds and foreign government bonds, we see that, since QE, there has been an increase in demand for higher-yielding bonds from sovereigns. Holdings of Canadian and Australian government bonds, for instance, have increased significantly since the start of QE, while the better rated emerging market local government bonds have also increased.



US investors stepped up investments in high-rated financials and the energy sector

Over the past few years, energy (oil and gas) and consumer discretionary (auto components, hotels and household durables) sectors have benefitted most from US capital flows after the two leading sectors government and financials. US investors have particularly stepped up their foreign investments in energy. In 2008, investors held USD 344 billion in equities and USD 56 billion in debt in the energy sector. Investments in equities have almost doubled and debt has nearly tripled since then.

Implications of US policy normalisation

A future hike in US interest rates could make other assets more attractive, making certain sectors more vulnerable. The data suggest that US investors have been increasingly showing more preference for relatively safe assets in their search for yield. We do, however, see some concentration in countries and in specific sectors, including energy. Indeed, since the first round of asset purchases or quantitative easing (QE), US investors have been gradually shifting to high-yield assets originating from Canada and Australia. The asset allocation is already changing with the recent oil price collapse.

Although, the announcement to end the asset purchase programme in mid-2013 led to volatility, particularly in emerging markets, foreign economies that received these capital flows have tried to improve their fundamentals since then. But those that are lagging will remain vulnerable. We think that much of the normalisation process will depend on how the process is communicated and managed. Fed officials have said recently that, in this process, they will take into account the impact on financial markets. Exactly how this will materialise is not yet known. A gradual approach that allows US policymakers to evaluate the impact will likely be the preferred option. We expect the Fed to hike interest rates slowly. We forecast the federal funds rate to rise to 1.0% at year-end 2015 and to 3% at year-end 2016. This would mean that the rate is hiked every other meeting from June 2015, followed by a step-up in hike every meeting until the rate reaches 3% in 2016.