Fed Rapidly Shifts to Hawkish Stance Amid Inflation Concerns
US Treasury Yields Surge on Expected Faster Tightening
Nasdaq Falls 3%, Bitcoin Drops 4%
[Asia Economy New York=Correspondent Baek Jong-min] The U.S. Federal Reserve (Fed) has signaled that it will begin reducing its balance sheet, which amounts to $8.8 trillion, within this year (quantitative tightening). It also indicated that interest rate hikes will be implemented early, making a rate increase in March highly likely.
Following asset purchase tapering, interest rate hikes and quantitative tightening are expected to be implemented in succession, which is anticipated to deliver a significant shock to the capital markets. After news of the Fed's quantitative tightening discussions emerged, U.S. Treasury yields surged sharply while stock markets reversed and declined.
The minutes of the Federal Open Market Committee (FOMC) meeting held in December last year, released on the 5th (local time), provided hints about the timing of the start of quantitative tightening, which had been a focus of market attention. The minutes reported that members discussed quantitative tightening and that some members mentioned it would be appropriate to begin quantitative tightening after starting interest rate hikes.
The minutes also stated that members mentioned interest rate hikes should "begin soon or proceed at a faster pace than previously projected amid rising inflation and a strong labor market."
The remarks in the minutes were interpreted as indicating that the first rate hike could begin at the March FOMC meeting. This scenario involves interest rate hikes occurring simultaneously with the completion of tapering. The Chicago Mercantile Exchange's FedWatch tool estimated the probability of a March rate hike at 67.8%. This probability increased by about 8 percentage points compared to the previous day.
CNBC forecasted that following the March rate hike, the Fed would begin quantitative tightening in the second half of the year.
The minutes also suggested that once quantitative tightening begins, the balance sheet reduction could proceed faster than the quantitative tightening in 2017.
The Fed is accelerating the pace of tightening due to concerns over soaring inflation. As of November last year, the Consumer Price Index rose by as much as 6.8%. The Wall Street Journal interpreted this as indicating that since inflation is likely to continue rising this year, the Fed may take a more aggressive stance.
The positions of Fed members revealed in the minutes also reflected concerns about rising inflation. The minutes stated, "Most members expected inflation to decline significantly this year, but they substantially revised upward their inflation forecasts for this year and projected that inflation would still rise in 2023."
Quantitative tightening is an issue that could trigger aftershocks not only in the U.S. but also in global capital markets. If the Fed reduces U.S. Treasury holdings that were increased during the COVID-19 response, market interest rates will inevitably rise. On the day of the minutes' release, the yield on the 10-year U.S. Treasury surged above 1.7% immediately afterward. The yields on the 2-year and 5-year Treasuries, which are sensitive to interest rate policy, also surged to their highest levels since the COVID-19 outbreak.
The rise in Treasury yields acted as a factor causing stock market declines. The Nasdaq index, sensitive to interest rates, closed down 3.3%. The Dow Jones Industrial Average, which had been on a recent upswing, turned downward after the minutes were released and closed down 1.08%, while the S&P 500 index plunged 1.9%.
Cryptocurrencies also weakened. Bitcoin's price fell 4%, barely maintaining the $44,000 level.
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