Working Paper Series no. 1040. This paper challenges the conventional wisdom that US monetary policy tightening attracts foreign capital through purchases of US Treasuries. Using bilateral data on US foreign assets and liabilities, we show that much of the observed capital inflows into the US is actually due to US investors repatriating funds from foreign equities. This highlights important heterogeneity between domestic and foreign investors. Extending the analysis to Central Bank Information shocks—monetary surprises conveying additional economic information—we document a distinct global portfolio rebalancing characterized by risk-on behavior, with US investors increasing foreign equity holdings and foreign investors shifting into US equities.
Effects of monetary policy shocks on bilateral capital flows
Non-Technical Summary
This paper examines how US monetary policy shapes international capital flows between the United States and foreign investors. A precise understanding of these flows is critical, as they determine which global markets are most at risk and whether the global response to monetary tightening is stabilizing or destabilizing.
Following an unexpected monetary tightening by the Federal Reserve, capital typically flows into the United States. These inflows are often attributed to increased foreign purchases of US Treasuries. Using detailed bilateral data on cross-border portfolio flows from 1994 to 2019, we show that this explanation is incomplete. A large share of observed inflows following a US monetary tightening actually reflects US investors bringing funds back from foreign equity markets. In other words, the response is driven less by foreign demand for US safe assets and more by US investors reducing exposure to risky assets abroad.
This distinction underscores important heterogeneity between domestic and foreign investors, as well as across asset classes.
We also study a second type of monetary surprise: Central Bank Information shocks, which arise when Federal Reserve announcements reveal new information about the economic outlook. Unlike conventional tightening shocks, positive information shocks, by signaling strong economic perspectives, trigger a global “risk-on” portfolio adjustment, i.e. an increase in risk-taking. US investors increase their purchases of foreign equities, while foreign investors simultaneously expand their holdings of US equities.
Overall, the paper shows that identifying which investors adjust their portfolios is crucial for understanding how US monetary policy spills over to global financial markets.
Keywords: Monetary Policy; Spillovers; Capital Flows
Codes JEL : F44, E52
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Updated on the 3rd of April 2026