Fed and Market Divergence: "Policy Stance Maintained Until Employment Recovery"

Inflation Concerns Rise but Fed Remains Calm
Tapering to Start After Job Recovery...Expected in 2Q Next Year
Need to Respond with Sectors Benefiting from Rate Hikes for Now

New York Stock Exchange on Wall Street, New York, USA
[Photo by Yonhap News]

[Asia Economy Reporter Minwoo Lee] Stock market volatility is expected to persist for the time being amid concerns over inflation and tapering (reduction of asset purchases). Although inflation may rise temporarily due to base effects and supply disruptions, employment recovery, which the U.S. Federal Reserve (Fed) closely monitors, remains sluggish. It is analyzed that in the face of ongoing monetary policy uncertainty, it is necessary to respond by focusing on sectors benefiting from inflation and rising interest rates.

On the 15th, IBK Investment & Securities predicted that the stock market would develop in this manner. When U.S. April inflation indicators exceeded expectations, the stable 10-year U.S. Treasury yield rebounded, causing global stock markets to fluctuate. Although the Fed expressed surprise at the sharp rise in inflation indicators, it maintained its existing stance that it is premature to discuss tapering. Given the difference in perspectives with the market, it is necessary to consider the Fed’s policy decision criteria.

The market’s inflation concerns grow, but the Fed remains calm... Why?

IBK Investment & Securities explained that the reason the Fed drew a line under policy changes despite current inflation is that it considers the inflation temporary. The U.S. Consumer Price Index (CPI) for April rose 4.2% year-on-year, significantly exceeding the previous month’s 2.6% and the expected 3.6%. This year-on-year increase was the highest since September 2008. However, detailed analysis shows that items heavily influenced by base effects and supply disruptions contributed significantly to the rise. Price increases in transportation-related goods and services reflect the semiconductor supply shortage for automobiles. The energy category also rose more than 25% due to base effects. Ultimately, the demand-side inflation pressure that the Fed wants to see has not been confirmed.

Researcher Soeun Ahn of IBK Investment & Securities said, "Employment and wage conditions, which are important foundations of demand-side inflation pressure, have not reached pre-COVID-19 levels," adding, "This is why the Fed does not react strongly to the sharp rise in inflation indicators and instead focuses on employment data recovery."

The key is ultimately employment... Recovery expected in Q2 next year

Since employment recovery is the key to the Fed’s policy shift, it is necessary to monitor it closely. Attention should be paid to employment conditions at the time of past tapering. During the global financial crisis, the Fed, which implemented quantitative easing in three rounds, began tapering in January 2014. At that time, 90% of the employment lost after the crisis had been recovered. The year-on-year inflation rate had also stabilized in the mid-to-high 1% range after fluctuations caused by base effects. Monetary policy normalization began even though employment was not fully recovered and inflation indicators were not overheated.

Currently, the recovery rate of U.S. employment hit by COVID-19 is only 63%. IBK Investment & Securities expects the employment recovery rate to reach 90% around the second quarter of next year. The federal government’s additional unemployment benefits, which likely affected the employment shock in April, are scheduled to continue until September. This means there are groups who do not necessarily need to seek employment until then. Investment pressure to induce new employment is also not significant. Researcher Ahn emphasized, "Unlike past economic crises, production capacity itself has not been severely damaged, so there is low pressure to adjust facility investment," adding, "Policies with high employment-inducing effects, such as infrastructure investment, are being promoted, but considering political uncertainties, it will take considerable time for legislation and implementation."

Need to respond with sectors benefiting from inflation and rising interest rates

Therefore, short-term inflation concerns are expected to continue. However, the Fed is expected to refrain from mentioning the start of tapering based on employment conditions as it does now. Stock market volatility may increase depending on economic indicator results released amid high policy uncertainty. Researcher Ahn advised, "It is necessary to respond by focusing on sectors relatively less uncertain and benefiting from ‘inflation and rising interest rates,’ such as finance, industrials, and materials, which have a high correlation with the U.S. and Korea’s breakeven inflation (BEI)."

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