[The Editors' Verdict] Will the Taper Tantrum Return?

"The Bank of England (BOE) does not understand quantitative easing (QE)."

This is the evaluation of the QE policy announced last week by the BOE's internal oversight body, the Independent Evaluation Office (IEO). The IEO pointed out that the lack of understanding of QE made effective communication difficult, turning it into a monetary policy that most people could not comprehend, which sparked controversy by causing asset price surges and wealth disparities.

In fact, many investors believe that QE aims to reduce the government's financing costs through central bank purchases of government bonds in response to the COVID-19 pandemic crisis. However, recently, asset prices have risen, and international commodity prices such as energy and metals are also on the rise. International crude oil prices (Brent crude) have surpassed $55 per barrel for the first time since the pandemic.

The rise in not only asset prices but also commodity prices carries a strong likelihood of leading to inflation, which has been forgotten over the past decade. Inflation expected by the market can be estimated by subtracting the yield of inflation-linked government bonds, whose principal and interest are linked to inflation, from the yield of nominal government bonds. Based on this, the estimated inflation rate in the U.S. exceeded 2% across all maturities as of January 5. Investors are re-evaluating the risks associated with rising prices. Inflation-linked bonds are gaining attention as the best means to hedge inflation risk and reportedly yielded a 35% investment return last year.

Price increases follow economic recovery. Although advanced countries are facing the worst situations, the stock market is shifting its leading sectors from technology stocks to cyclical stocks, anticipating a full-scale economic recovery after COVID-19 vaccinations. Concerns about inflation stem from demand factors such as pent-up consumption and supply inefficiencies caused by the malfunctioning of global value chains (GVC) due to U.S.-China tensions.

A greater concern is the U.S. Federal Reserve's monetary policy, which has adopted the Average Inflation Targeting (AIT) framework and is willing to tolerate inflation exceeding 2%. The Fed's policy shift aims to lower real interest rates sufficiently through inflation expectations to stimulate economic recovery. As intended by the Fed, real interest rates measured by inflation-linked bond yields are trending downward from negative values.

The problem is that despite inflation, the Fed may not respond with policy measures to keep interest costs on government bonds issued to finance massive fiscal spending low, as many investors anticipate. The economic stimulus plan announced by President-elect Joe Biden, who won the election and secured both chambers of Congress, increases this possibility.

As experienced in the 1970s, when long-term inflation expectations form, market interest rates rise, and central banks' attempts to lower them only fuel inflation further. Yield Curve Control (YCC) is only feasible when inflation is low.

When inflation expectations are widespread, the Fed has no practical benefit in maintaining AIT and will inevitably have to reverse QE, which could trigger a tightening shock (taper tantrum) similar to that in 2013. This is why the UK Telegraph recently published an article titled "Biden has pulled the trigger on the taper tantrum." Although the possibility is low, inflation could completely shake the financial ecosystem built over the past decade.

Kyungsoo Kim, Professor Emeritus, Sungkyunkwan University

This content was produced with the assistance of AI translation services.