Fed to Begin Tapering as Early as November... Laying Groundwork for Interest Rate Hikes Next Year

September FOMC Minutes Released
Members Say "Tapering Could Start as Early as November, No Later Than December"
Plan to Complete Quickly by Mid-Next Year
WSJ: "Laying Groundwork for Rate Hikes Next Year"
Possibility of Accelerated Rate Hikes Amid Rising Inflation Concerns

[Image source=Reuters Yonhap News]

[Asia Economy New York=Correspondent Baek Jong-min] The U.S. Federal Reserve (Fed) is expected to begin tapering (reducing asset purchases) as early as November. With ongoing concerns about inflation in the U.S., the implementation of tapering is anticipated to cause U.S. Treasury yields to rise and the benchmark interest rate to increase, which will have ripple effects on the international financial markets.

According to the minutes of the September Federal Open Market Committee (FOMC) meeting released by the Fed on the 13th (local time), members mentioned that economic support measures could be reduced as early as November.

The minutes stated, "Members generally assessed that the economic recovery is progressing smoothly and considered a gradual tapering to complete asset purchases by around mid-next year to be appropriate."

The minutes also noted that if members decide on tapering at the next meeting, it is expected to be implemented from mid-November or mid-December. The tapering completion date was forecasted to be July of next year.

To overcome the economic impact of the COVID-19 pandemic, the Fed has been purchasing $120 billion worth of Treasury securities and mortgage-backed securities (MBS) monthly. Fed members proposed reducing the purchase amounts by $10 billion for Treasuries and $5 billion for MBS each month.

According to the minutes, the Fed is scheduled to decide on tapering at the FOMC meeting held on November 2-3, with only the procedure to determine the implementation date remaining. Most Wall Street experts expect implementation in December, but with persistent inflation, a November start cannot be ruled out.

Coincidentally, on the same day, the September Consumer Price Index (CPI) was announced to have risen 5.4% year-over-year, fueling concerns about sustained inflation. Rising oil and food prices are driving inflation.

With inflation rising, the U.S. Social Security benefits reflecting the cost of living for next year have been confirmed to increase by 5.9%, the highest rate in over 40 years.

Professor Son Seong-won of Loyola Marymount University warned of the possibility of sustained inflation, saying, "Wages are rising due to a labor shortage, and consumers have increased savings through government stimulus, so companies are not hesitating to raise prices."

There is a noticeable shift in the Fed’s stance that inflation is temporary. The minutes revealed, "Most members see a high likelihood that supply chain bottlenecks and labor shortages will have a prolonged impact on rising inflation."

Although members emphasized that the start of tapering is not a signal for a rate hike, the Wall Street Journal reported that the accelerated tapering schedule is seen as a move anticipating interest rate increases.

It is analyzed that inflation may exceed the Fed’s 2% target for a considerable period, laying the groundwork for rate hikes next year. According to the Fed’s dot plot, half of the 18 members expect rate increases by the end of next year.

Despite inflation concerns and the announcement of tapering, the 10-year U.S. Treasury yield rose to 1.6% before falling back to 1.542% on the day. The short-term 2-year Treasury yield increased to 0.368%.

The Wall Street Journal (WSJ) interpreted the narrowing gap between short- and long-term Treasury yields as reflecting investors’ expectations that the Fed will raise rates faster than anticipated and that long-term growth prospects are weakening.

WSJ also reported that with tapering announced, forecasts that U.S. Treasury yields will rise to 2% within the year are gaining renewed momentum.

Rising Treasury yields contribute to a stronger dollar and lower commodity prices. Since higher Treasury yields burden technology stocks, this could negatively impact the stock market as well.