The party is winding down

Joo Jung-wan
The author is the economic news editor at the JoongAng Ilbo.

The party is coming to an end for the global financial market. The host, the U.S. Federal Reserve, last year launched a lavish generous party for global capital, with interest rates in the zero-percent range backed by infinite quantitative easing. The binge was the biggest since the 2008 global financial crisis.

Big capital borrowed money cheaply and easily to invest in stocks and properties to augment their wealth. Now the host is ready to clear out the table and bring order back to the house.

On Thursday, the U.S. central bank will announce the results of its two-day Federal Open Market Committee (FOMC) meeting. The FOMC, which holds eight meetings a year, is expected to signal the direction of tapering after the meeting. It could specify the timetable and means for rolling back the Federal Reserve’s bond purchase program. Although the Fed previously signaled no rate hikes before 2024, the tightening could take place faster.

When likened to a pond, the global economy last year faced a sudden drought (recession) from the Covid-19 pandemic. If left unattended, all fish (economic players) could die. Central banks pumped in liquidity through all possible means to keep the pond from drying up and devastating its inhabitants. The risks of such extreme measures have to be taken at times of emergency. As the pandemic continued into a second year, the liquidity pump was kept on. Conditions have improved, and waters have reached normal levels.

The real problem with the pond starts now. The water level must not be too low or too high. In Korea, the liquidity level is deemed excessive. So came a draining job. The Bank of Korea (BOK) in August raised the base rate from the historic low of 0.5 percent. After last month’s monetary policy meeting, Governor Lee Ju-yeol indicated an additional hike. He said that if the economy flows as expected, the Monetary Policy Board of the central bank could consider another rate hike at the next meeting in November. The BOK holds this year’s last monetary policy meeting on Nov. 25 to determine if another hike is really needed.

The U.S. conditions are slightly different from Korea’s. The Fed has kept its target rate at 0.00 percent to 0.25 percent and has been purchasing bonds — Treasuries and mortgage-backed securities — worth $120 billion on a monthly basis. The action was aimed at stimulating the economy by lowering interest rates on long-term bonds. The Fed has benchmarked the quantitative easing program Japan has used to fight deflation.

The Fed plans to start tapering by reducing its monthly bond purchases. In other words, it intends to continue pumping in water but not as much as before. Strictly speaking, tapering is not about tightening money. But since tapering heralds a monetary tightening, the move scares investors. Once the water level is lowered by tapering, the authority would be ready to raise its benchmark rates.

In September, Fed Chair Jerome Powell suggested the tapering will end by mid-2022, starting as early as November and wrapped up by mid-2022. Market experts expect the Fed to raise the benchmark rate in the second half of next year at the earliest.

A shift to monetary tightening would push up Treasury yields. Higher borrowing rates could upset emerging markets more than the U.S. Investors could yank out money from emerging markets to invest in U.S. assets which yield higher returns. The phenomenon actually happened when the Fed entered tapering in 2013. Currencies and stocks of emerging economies tumbled on the so-called taper tantrum.

Alarm bells have already started ringing. In Korea, the benchmark three-year government bond yield jumped to 2.1 percent, the highest since August 2018. Higher market yields translate into higher lending rates. Investors who went on debt-financed asset buying sprees must take precautions. If they linger after the party is over, they could pay a dear price.