Capital Inflows to Emerging Countries and Their Reflux to the United States

Under the prolonged accommodative financial environment in developed countries, incentives to search for yield have increased among investors. This has prompted capital inflows to emerging countries with high growth prospects (high expected returns) in recent years. In these circumstances, the correlation coefficients of changes in asset prices among emerging countries have reached an unprecedentedly high level, reducing the benefits of internationally diversified investment. Concurrently, many of the emerging countries, faced with a significant amount of capital inflows, appear to be intervening massively in the foreign exchange market to keep their currencies from appreciating sharply. The accumulated foreign reserves resulting from the interventions have tended recently to be invested increasingly in longer-term U.S. Treasuries, and it is possible that this tendency is putting downward pressure on U.S. long-term interest rates. The decline in these rates may cause an acceleration of capital inflows to the emerging countries by further encouraging investors to search for yield. The recent international capital flows suggest that a "feedback loop" is operating between developed and emerging countries, and therefore careful attention should be paid to future developments, including the possibility of a reversal of capital flows.