Fed’s tapering requires preparation for interest rate rise and bubble collapse

The Federal Reserve (Fed), the central bank of the U.S., said tapering, which reduces liquidity provided in the market by buying bonds, etc., will begin in November. As tapering naturally leads to an interest rate rise, it means the zero-rate period will end soon in the country. It is bound to affect future actions by the Bank of Korea, which preemptively raised the base rate in August.

“Slowing the pace of asset purchases may soon be justified if progress (in inflation and employment) continues largely as expected,” the Fed said in a statement announced on Wednesday. Fed Chair Jerome Powell also said that tapering “could come as soon as the next meeting.” If tapering is decided at a meeting of the Federal Open Market Committee (FOMC) in early November and is carried out into the next year, an interest rate hike can begin in the second half of next year. Tapering is not necessarily negative as it signals that the U.S. economy is recovering from the shock of COVID-19. What’s problematic, however, is that money can quickly outflow from the financial markets in emerging countries, which pose a higher risk. A similar situation unfolded in 2013 when a high level of liquidity from the global financial crisis was reduced.

The South Korean Ministry of Economy and Finance said the Fed’s decision will have limited impact on the domestic financial market but warned that volatility might increase. The risk factors that could affect the South Korean economy with the ending of the low-interest period are 222 trillion won of small business owner debt, whose payment of principal and interest has been delayed since the outbreak of COVID-19 and over 1,800 trillion won of household debt. If the Bank of Korea further increases the interest rate to prevent the outflow of foreign funds, the interest burden on households and business owners will sharply increase.

The trend of increasing mortgages and loans for deposits triggered by skyrocketing housing prices and deposits is continuing despite the financial authorities’ strong actions to reduce loans. The debt burden on the vulnerable groups is further increasing, as seen in the case of those in their 20s whose household debt is rising more than twice as fast as other age groups due to rapidly increasing deposits and monthly rents as well as financial difficulties. In addition, even stronger measures to reduce debt will be introduced next month. Regulations on margin account loans, in which an investor borrows against the value of securities owned from non-banking financial institutions and securities firms, will be strengthened.

Once the U.S. accelerates tight fiscal policy, a bubble in asset prices, including stocks, cryptocurrency, and real estate, can collapse faster than expected in the world. Households and businesses should prepare for the high-interest period by refraining from unnecessary loans and reckless investment.