Fed Signals Tapering This Year, US Tightening Shock Repeats?... Korean Stock Market Already in Impact Zone

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The U.S. central bank, the Federal Reserve (Fed), clearly signaled on the 18th (local time) that it will withdraw its emergency monetary policy implemented due to COVID-19. The commencement of tapering (asset purchase reduction) at a scale of $120 billion per month is bound to affect most asset markets including international finance, stock markets, foreign exchange, cryptocurrencies, and gold. This is precisely the point that the Fed is most concerned about.

When then-Fed Chairman Ben Bernanke signaled tapering in 2013, market interest rates soared, capital outflows from emerging markets occurred, and stock markets plunged simultaneously, a phenomenon known as the "taper tantrum." Jerome Powell, the current Fed Chairman, has repeatedly insisted that the conditions for tapering are not yet ripe despite inflation concerns, conscious of this past experience.

However, this year's situation is unfolding differently from the past. The feared taper tantrum has not appeared. The sharp drop in the U.S. stock market following Powell's mention of the possibility of reducing Fed's asset holdings in 2019 also did not recur.

On the contrary, recent U.S. Treasury yields have been falling day after day, and major indices on the New York Stock Exchange have been hitting record highs. The capital market's behavior on the day tapering was announced was not much different.

On the New York Stock Exchange, the Dow Jones Industrial Average and the S&P 500 index fell by 1%, but this was only about a 2% correction from their peak. The 10-year Treasury yield approached 1.3% before the FOMC minutes release but gave back its gains afterward, closing at about 1.26%, similar to the previous day. Earlier, the 10-year Treasury yield rose from 0.9% at the beginning of the year to 1.7% reflecting inflation concerns but has since steadily declined. The 30-year yield also fell that day. The 5-year yield, a short-term bond, was also on a downward trend.

Regarding the stability of long-term 10-year and 30-year Treasury yields despite expected tapering and rate hikes, Lun Linjen, U.S. bond investment strategist at BMO Capital Markets, explained, "The market reflected the view that there will be no tapering in September due to differing opinions among Fed officials." This is interpreted as a more dovish stance despite concerns about the possibility of tapering in September.

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Jiwei Ren, portfolio manager at Penn Mutual Asset Management, explained, "The market expects the Fed to stop raising rates at 1.5% or 1.6%."

Regarding the stock market, although short-term corrections may occur as most catalysts for further rises have been exhausted, opinions suggest that the upward trend can continue based on strong corporate earnings. Chris Zaccarelli, Chief Investment Officer of Independent Advisor Alliance, forecasted, "With positive economic news continuing, the market could form new highs by the end of the year."

Fahad Kamal, Chief Investment Officer (CIO) at Kleinwort Hambros, also argued, "The stock market environment continues to improve as policies are reasonably supported, growth continues, and vaccination rates increase."

Charles Hepworth, Investment Director at GAM Investments, also supported the bullish market view, saying, "Stimulus still exists. It is uncertain whether we will see a severe stock market correction."

Until early this month, the domestic stock market was aiming to return to the 3300 level on the KOSPI, but it has been wobbling day after day. As of 9:40 a.m. on the 19th, the KOSPI recorded 3153.02, down 5.91 points (0.19%) from the previous day. The KOSPI fell for eight consecutive trading days from the 5th to the 17th, rebounded slightly the previous day, but showed weakness again on this day. Due to recent declines, the KOSPI fell below the 3200 level for the first time in about two months based on closing prices.

Foreign selling pressure is dragging down the KOSPI. Foreigners have sold 28.7354 trillion KRW in the KOSPI since the beginning of this year. April was the only month with net buying. They bought 371.6 billion KRW in April, but showed selling pressure in all other months. Foreigners showed buying in the domestic stock market at the beginning of this month by reducing their Chinese holdings due to regulatory issues in China, but turned to selling again from last week. They sold 7.7242 trillion KRW from the 9th to the day before.

Kim Byung-yeon, a researcher at NH Investment & Securities, analyzed, "The direct cause of the recent KOSPI decline is large-scale net selling by foreigners," and speculated the background to be reduced additional policy stimulus, macro momentum peaking out, concerns over semiconductor price cycle decline, and the spread of the COVID-19 Delta variant, noting that volatility in the Korean stock market is excessive compared to other countries.

It seems time is needed before a trend reversal to an upward trajectory. Labor Gil, a researcher at Shinhan Financial Investment, explained, "While there is a possibility of controlling the speed of foreign selling and index decline, time is needed before a trend reversal to an upward trajectory," adding, "Investors are reflecting a slowdown in economic recovery, which is unfavorable for emerging market stocks that are relatively weaker within equities."

The future trend is expected to depend on the speed of U.S. interest rate hikes. Researcher Kim said, "The KOSPI is expected to rise again as the short-term sharp decline calms down," but added, "However, the concern arises after recovering to a certain level. If U.S. employment normalizes and the Fed gains confidence in the U.S. economic recovery, the speed of rate hikes may accelerate, making risky assets sensitive to rising discount rates."

Gold, crude oil, and cryptocurrencies cannot ignore tapering. Since they are traded in dollars, they tend to fall when the dollar strengthens.

Recently, the dollar has shown strength reflecting the possibility of economic slowdown due to the spread of the Delta variant and geopolitical concerns from the Afghanistan situation, but on this day, the dollar index gave back its intraday gains and closed at a level similar to the previous day at 93.147. This is contrary to the expectation that tapering would induce dollar strength. Meanwhile, gold showed an upward trend that day.

Mark Waller, Head of Research at OREX.com, explained, "Gold prices rose and the U.S. dollar fell due to the interpretation that the minutes were dovish." If the rise in U.S. Treasury yields is limited, dollar strength will also be limited. However, the dollar strength factor remains if the Delta variant spreads further.

There is also analysis that if central banks worldwide tighten monetary policy starting with the Fed, cryptocurrency prices will be negatively affected. Investment bank Stifel judged that the slowdown in monetary supply worldwide could burden Bitcoin. The analysis is that if liquidity, which increased during the COVID-19 crisis, decreases, the upward momentum of cryptocurrencies will be blocked.

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