Bracing for the end of U.S. easing

World financial markets have been wobbly in recent weeks amid fears the U.S. Federal Reserve could wind down and terminate its quantitative easing program as the American economy begins to show signs of recovery. Volatility in the U.S. stock market pushed emerging market equities into the bear zone. The dollar has been fluctuating and currency values of emerging markets have fallen sharply. Government bond prices are plummeting. If the rattling in financial markets continues, the real market could be affected. The global market could sink back if the spending spirit is dampened by the fizzling of asset bubbles.

The market instability was triggered by the release of the minutes from the Fed’s policy-setting committee that suggested some officials were arguing for a slowing in the massive bond-purchase program as early as this month. The Fed has been flooding liquidity and keeping interest rates to near zero since 2008 to help stimulate the U.S. economy following the financial meltdown. The funds helped inflate financial assets in emerging markets. But if the Fed shifts to tighten monetary policy, the funds could return back to the United States, wreaking havoc on Asian and other emerging markets.

The Fed is unlikely to terminate the quantitative program suddenly. But it may cut back on its massive monthly scale of $85 billion. The U.S. economy is already nearing the conditions the Fed laid out for terminating quantitative easing - unemployment rate of 6.5 percent and inflation rate of 2 percent. Chairman Ben Bernanke last month indicated that he could taper off the pace of purchases when the Fed is convinced that improvements in the labor market are sustainable. We will just have to take the Fed on its word that it will wind down its bond purchases in an orderly and predictable fashion. It should also keep central banks in other key markets informed and alerted to any forthcoming changes in its tightening policy.

Seoul authorities also should watch movements in the U.S. economy closely. A response after the U.S. exit strategy takes off would be too late. We have to be ready to take immediate action to buffer any negative impact on local markets and the economy from future U.S. moves.

Authorities should be watchful of any sudden inflow of short-term capital. That would most likely be speculative funds seeking short-term gains. A mass exodus of foreign funds shaking the equity and capital market could further hurt the fragile economy. Government and financial authorities should keep their eyes open and stay alert and ready to protect the local market.