This paper examines the transmission of changes in the U.S. monetary policy to localcurrency
sovereign bond yields of Brazil and Mexico. Using vector error-correction models,
we find that the U.S. 10-year bond yield was a key driver of long-term yields in these
countries, and that Brazilian yields were more sensitive to U.S. shocks than Mexican yields
during 2010–13. Remarkably, the propagation of shocks from U.S. long-term yields was
amplified by changes in the policy rate in Brazil, but not in Mexico. Our counterfactual
analysis suggests that yields in both countries temporarily overshot the values predicted by
the model in the aftermath of the Fed’s “tapering” announcement in May 2013. This study
suggests that emerging markets will need to contend with potential spillovers from shifts in
monetary policy expectations in the U.S., which often lead to higher government bond
interest rates and bouts of volatility.
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