Among various economic indicators such as economy, inflation rate, unemployment rate, and trade balance, the target variable that can most accurately read whether or not the COVID-19 crisis has been overcome is the money supply. This is because “tapering” (reduction in quantitative easing), which reduces the supply of money, is promoted when a lot of money is released during a crisis phase immediately after the Corona 19 crisis and starts to be overcome as in recent times.
The talkative tapering was picked up by the US central bank (Fed) meeting in June. What is curious is that tapering, which was discussed four years after the financial crisis, was mentioned only one year after the Corona 19 crisis. The financial crisis must be overcome in the order of liquidity, system, and the real economy. Tapering has been promoted when the economy has recovered and the employment indicator, a lagging indicator, begins to improve.
Fed faces COVID-19 crisis 100 years after its founding
According to the three step theory of overcoming the crisis, the initial impact of a financial crisis may be small as it stems from a systemic crisis, but it takes time to recover. During the financial crisis, a lot of money was released to address liquidity, and it wasn't until 2013 that tapering was first mentioned. It takes time to resolve the financial crisis.
On the other hand, the COVID-19 crisis, which is the first case of a new normal dystopia, is characterized by a very large initial shock. As soon as this incident occurred, everyone was terrified, and the reason why the world stock price plummeted to the point of being cut in half in a month is because it is the “danger no one knows” that is the most dangerous in Hyman Minsky risk theory.
The Fed is walking a path that has not been taken since its establishment in 1913 to combat the COVID-19 pandemic. Until the situation subsides, it declared a policy of supplying an unlimited amount of dollars to any purchase target. It was criticized for abandoning the central bank's unique function of "lender of last resort."
However, unlike the previous crisis caused by system problems, the highly contagious COVID-19 crisis could quickly change the global economy from 'isolated' to 'connected' if only a vaccine was distributed. If the growth rate rises in the absence of recovering the loosed money, concerns about asset bubbles and inflation arise. It is for this reason that tapering is already being discussed regardless of whether it is actually promoted or not.
Looking at the US long-term and short-term expected inflation, it is high enough to approach 3% after two years, but falls below 2.5% after 10 years. This is an indication of the possibility that the recent inflation will be only a temporary phenomenon. It is for this reason that most of the people in the Fed are cautious about tapering.
Fed officials, as if in a chorus, are expressing their willingness to ease the economy. But the market no longer wants it. Rather, I think there is a demand for reverse repo even though the return is 0.08%. Reverse repo refers to an act that financial institutions deposit with the central bank when the price of a target for investment rises above the appropriate value and the risk of a bubble burst is higher than the expected return for additional investment.
It is in this context that the Fed decided to urgently sell the junk bonds it purchased through the Secondary Market Corporate Bond Fund (SMCCF) in March last year. Although the Fed insists that the decision to sell junk bonds is not tapering, the market sees it as a start, in principle, as a liquidity control policy that targets only investment-qualified instruments such as government bonds and mortgage-backed securities.
At the Fed meeting held in June, the market reaction was so accepted that the term “kick-off” was coined from the start. Kick-off is widely used to mean 'to start', but it also contains the meaning of 'an unexpected variable may occur'.
Korea showing signs of interest rate hike ahead of US
After the Fed meeting in June, a new question is whether Korea needs to raise interest rates before the Fed raises rates.
As for the Bank of Korea's preemptive rate hike, the Fed's new standard of "taking into account not only economic indicators but also the financial market response" can be an important clue when determining the timing and speed of rate hikes after the financial crisis.
Unlike tapering, an increase in the base rate has a large impact on the financial markets, including the stock market, and the path of monetary policy delivery (change of interest rate → change in aggregate demand → regulation of the real economy).
If the relationship between the base rate and the financial market is “stable” in the interest rate system of a particular country, it is not necessary to pay attention to the reaction of the financial market, but the US has been unstable since the rate hike in 2004. After the financial crisis, despite lowering the base rate to zero, liquidity has been supplemented by quantitative easing as the financial market situation has become more tense.
Another criterion to consider is the 'best control rule'. The best control rule is how the Fed operates monetary policy by calculating a base interest rate path that minimizes deviations from the two major targets. In terms of flexibility to reflect market conditions, it is significantly different from the previous method of managing monetary policy based on an appropriate interest rate calculated according to the Taylor rule.
Combining the two criteria gives the answer to the second question. When the timing and speed of interest rate hikes are determined by considering both economic indicators and the reaction of the financial market, they can advance or delay the rate hike path according to the best control rule.
If there is concern about a shock to the financial market when raising interest rates, it is expected that the timing will be later than the path under the best control rule, and vice versa.
Given the convergence of the Fed's monetary policy to the market, the issue of tapering is likely to be the biggest issue at the Jackson Hole meeting to be held in August. What is clear is that tapering is a policy judgment that the crisis is being overcome normally. Rather, continuing financial easing could lead to giving more drugs to drug patients, which could even lead to a loss of economic resilience.
Investments should be prepared in advance. When the transition from quantitative easing to tapering, the most sensitive stock investment can defend returns by adjusting from large tech stocks to cyclical stocks and dividend stocks.
Leverage products based on low interest rates and investment vehicles with bubbles should be sorted out. As the economy returns to normal, it is time to refrain from following Tesla CEO Elon Musk and Arc Asset Management CEO Kathy Wood.
Ahead of the tapering initiative, the Bank of Korea is formalizing an interest rate hike within this year. However, unlike tapering, the timing and pace of US interest rate hikes are variable, so it is questionable whether Korea needs to raise interest rates first.
According to data analyzed by the Central Bank of Canada on 23 emerging countries, Korea is the least likely to leave foreign capital following a US interest rate hike. The most effective way to deal with the outflow of foreign capital in emerging countries is not to raise interest rates, but to build up enough foreign exchange reserves.
Including second line funds secured through currency swaps, Korea's foreign exchange reserves amount to $550 billion, which is more than $150 billion more than the appropriate foreign exchange reserves estimated by the captiyun model in the broadest sense.
The view that interest rates should be raised in order to reduce household debt also needs to be recalled in November 2018, the so-called ‘Kim Hyun mi nightmare’ that raised interest rates to catch house prices in Gangnam at the time and further stagnates the economy. It should be borne in mind that if interest rates are raised in a situation where household debt has already exceeded the risk level like in Korea, the burden may even appear as a ‘scarring effect’ that concentrates on the MZ generation (millennials + generation Z) and small business owners.
