US Treasury Yield Rises to 1.7% · Nasdaq Falls 3.3%... Global Markets 'Shake'

Bitcoin Cryptocurrency Price Falls to the $42,000 Range
Japan's Nikkei Drops 1.26%...Domestic Stock Market Also Shocked
Fed Assets Double in 2 Years...Inflation Suppressed by Asset Reduction

[Asia Economy New York=Correspondents Baek Jong-min, Park Byung-hee, Lee Min-woo, Jang Se-hee] On the 5th (local time), the minutes of the December Federal Open Market Committee (FOMC) revealed that the U.S. Federal Reserve (Fed) is expected to take more aggressive actions to curb inflation, plunging global financial markets into turmoil.

The Fed's stance to raise interest rates in March and to begin balance sheet reduction (quantitative tightening, QT) amounting to $8.8 trillion within the year signals a complete shift from economic stimulus to tightening. This is interpreted as a clear warning to capital markets, including stocks, bonds, exchange rates, and cryptocurrencies, which had been thriving under accommodative monetary policies.

Shockwaves in Stock and Cryptocurrency Markets... Dollar Strength Likely to Continue

Immediately after the release of the minutes, U.S. Treasury yields surged across the board, including short-term 2-year and 5-year notes as well as long-term 10-year and 30-year bonds. The 10-year yield soared above 1.7%. Rising yields indicate falling bond prices.

As Treasury yields spiked, the Nasdaq index, which is growth-stock heavy, plunged 3.3%. The cryptocurrency Bitcoin also free-fell to the $42,000 range. As of 9:56 a.m. on the 6th in Tokyo's stock market, the Nikkei 225 index was trading at 28,961.58, down 1.26% from the previous trading day.

South Korea's stock market was not spared from the U.S.-originated chill. As of 10:24 a.m. on the 6th, the KOSPI stood at 2,934.56, down 0.66% from the previous day, and the KOSDAQ was at 991.35, down 1.81%.

Besides the Fed's stronger-than-expected hawkish remarks, the sharp decline in trading volume compared to January last year also appears to have affected the sluggish 'January effect' in the stock market at the start of the year. There is also analysis suggesting that the sentiment to secure funds for LG Energy Solution's initial public offering (IPO) at the end of this month has dampened the rally.

Following the Fed's indication of quantitative tightening after interest rate hikes, the won-dollar exchange rate opened at 1,200.9 won, up 4 won. As the pace of the Fed's monetary tightening accelerates beyond expectations, forecasts suggest the early-year trend of dollar strength will solidify.

The exchange rate surpassing 1,200 won at the opening price is the first since July 27, 2020 (1,201.2 won). Intraday surpassing of 1,200 won occurred for the first time in three months since October 12 last year (1,200.4 won). However, the rise narrowed afterward, and trading continued around the 1,199 won level in the morning.

With the U.S. actually tightening the money supply, the dollar's strength is expected to persist. Oh Chang-seop, a researcher at Hyundai Motor Securities, explained, "Quantitative tightening actually reduces the money supply itself, which acts as a factor strengthening the pressure for dollar appreciation. It is expected to stabilize around the 1,200 won level in the first half of the year, and the dollar strength trend is likely to continue in the second half as well."

The government has left room for intervention if the exchange rate rises excessively. Lee Ok-won, First Vice Minister of Strategy and Finance, stated, "If rapid volatility expansion occurs, we will strengthen efforts to stabilize the market."

Quantitative Tightening Announced Immediately After Interest Rate Hike

The December FOMC minutes released that day hinted that the first interest rate hike could begin at the March FOMC meeting.

Although the Fed's December dot plot forecasted three rate hikes next year, most experts had anticipated increases in May or June. However, according to the minutes, participants mentioned that "raising the policy rate earlier or faster than expected could be justified." Michael Feroli, Chief U.S. Economist at JPMorgan Chase, explained, "The Fed has firmly confirmed a strong pivot toward rate hikes."

The market immediately reflected the Fed's shift. The Chicago Mercantile Exchange's FedWatch tool estimated a 67.8% chance of a rate hike in March, about 8 percentage points higher than the previous day.

Jerome Powell, Chairman of the U.S. Federal Reserve (Fed)
[Photo by AP Yonhap News]

What surprised the market even more that day was quantitative tightening. Quantitative tightening is the opposite of quantitative easing (QE), meaning the Fed recovers liquidity it had injected into the market by selling bonds it purchased during QE.

Shima Shah, Chief Investment Strategist at Principal Global Investors, explained, "Investors expected the Fed to raise rates this year, but they did not anticipate that quantitative tightening would follow immediately after rate hikes, which caused a significant market shock."

The Fed's holdings doubled over two years since the COVID-19 pandemic, reaching $8.7575 trillion as of the 27th of last month. The Fed's asset reduction can be a tool to reduce market liquidity and curb inflation. The Fed is expected to engage in quantitative tightening by not rolling over maturing bonds or by selling bonds in the market. This will inevitably lead to rising market interest rates.

In the past, the Fed attempted quantitative tightening several years after starting rate hikes. After ending the third round of QE in October 2014, the Fed maintained asset size for three years and began quantitative tightening in October 2017. However, this time, quantitative tightening is expected to begin immediately in the second half of the year following the start of rate hikes in the first half. According to the FOMC minutes, participants mentioned that the appropriate pace of balance sheet reduction would likely be faster than previous normalization cases.

The Fed is rushing tightening due to significant concerns about inflation. As of November last year, U.S. inflation reached 6.8%. Compared to the Fed's usual inflation target of 2%, patience is difficult. The New York Times also judged that quantitative tightening could raise long-term interest rates, increasing borrowing costs and reducing demand.

Earlier, Fed Governor Christopher Waller emphasized in December last year that there was no reason to delay quantitative tightening. He said, "If quantitative tightening starts by summer 2022, there will be less need to raise the policy rate significantly." Waller also provided grounds to estimate the scale of quantitative tightening at about $4 trillion.

The stable recovery of employment is also a factor enabling the Fed to pursue early tightening. According to U.S. employment research firm ADP, private employment increased by 800,000 in December, double market expectations. The NYT also reported that the labor market's rapid improvement has shifted the Fed's focus toward taming inflation. The positive employment situation means there is a consensus to act preemptively before inflation becomes more entrenched.

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