[Square] How Do Changes in Monetary Policy Affect Financial Markets?

The biggest topic in the financial market for the New Year 2022 is the normalization of monetary policy, that is, the beginning of the exit strategy. The actual forecast for the base interest rate hike has been raised from June to March, and the number of rate hikes has increased from three to four, further strengthening the hawkish stance. The stock market, which is facing changes in monetary policy, is increasing volatility, forgetting the January effect, and as interest rates rise, the debate over leading stocks between value stocks and growth stocks, similar to early last year, is reemerging.

Although the normalization of monetary policy is a burden on the financial market, it is not a major concern as it is a natural phenomenon occurring during the process of economic improvement. However, the market tends to increase volatility depending on the speed of tightening policies during the normalization process rather than the normalization itself. The increased volatility in the U.S. stock market since the beginning of the year is judged to reflect concerns that the pace of tightening will accelerate rather than just the effect of monetary policy normalization.

With inflationary pressures, supply chain bottlenecks, and structural changes in the labor market triggering a faster tightening clock, growth stocks have taken a direct hit, and as mentioned at the beginning, investors’ concerns between growth stocks and value stocks are expected to deepen.

Whenever such difficult judgment periods arise, reviewing meaningful past events often provides hints for future investment decisions. To anticipate the speed of normalization, it is necessary to reconsider why monetary policy became accommodative in the past. The reason monetary policy became accommodative in March 2020 was due to the COVID-19 pandemic, which we are still experiencing. So, what was the situation before the pandemic?

Before the pandemic, the U.S. economy experienced an expansion phase for about 10 years after the financial crisis. However, despite the apparent long-term boom, the U.S. 10-year Treasury yield’s peak has been continuously declining. In other words, despite the economic boom, the U.S. potential growth rate was steadily decreasing. We experienced the pandemic in this chronic low-growth environment and faced a sharp economic downturn. Accordingly, large-scale economic stimulus measures, including accommodative monetary policy similar to the financial crisis, were implemented to defend the economy. In particular, the U.S. Federal Reserve (Fed) exerted efforts to stimulate the economy by even changing existing rules, and in the process, introduced the Average Inflation Targeting (AIT) as an extraordinary measure. As a result, the downward economic trajectory was barely restored to its original position, and discussions on the exit strategy have officially begun this year. Since the economy has returned to its original position, the normalization of monetary policy is considered a natural outcome.

However, attention should be paid to the fact that the economic trajectory has returned to its original position. This means it is a continuation of the long-term boom from 2008’s financial crisis until 2019, which can also be described as a return to a low-growth phase.

In this situation of returning to a low-growth phase, how high can the U.S. base interest rate rise? Of course, unlike the financial crisis, there is a persistent risk that interest rates may rise to a higher level than in 2019 to suppress inflation amid ongoing inflationary pressures caused by large-scale fiscal policies. However, the fact that temporary large-scale fiscal policies significantly influenced inflation also suggests that their effect is likely temporary.

In conclusion, excluding the major event of the pandemic, if this year is a continuation of 2019, it is time to seriously consider where we should focus between value stocks and growth stocks.

Park Kwangnam, Head of Digital Research Team, Mirae Asset Securities

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