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The Fed-triggered “taper tantrum” is taking its toll on Korean financial markets

The Korean won plunged against the dollar on September 26, 2023 (Courtesy of News1 Korea)
South Korean financial markets were rocked by a new taper tantrum after the U.S. Federal Reserve chairman signaled further tightening last week, triggering selloffs in the Korean currency, bonds and stocks.

On Tuesday, the US dollar closed at 1,348.50 won, up 12 from the previous session. This is the highest level since November 23 and marks a 10-month low for the Korean currency. The dollar/won even reached an intraday high of 1,349.50.

The Korean currency extended its losing streak on the strength of the dollar after the 10-year U.S. Treasury yield rose to 4.5%, its highest in 16 years.

The U.S. dollar index, a measure of the dollar’s value relative to a basket of six foreign currencies, climbed to 106.10, its highest level since November last year.

The dollar index and U.S. Treasury yields shot up after Federal Reserve Chairman Jerome Powell announced further interest rate cuts last Wednesday.

Korean bonds followed the lead of their U.S. counterparts on Tuesday. The 10-year note yield gained 4.2 basis points to close at 4.054%, hitting a new high this year after breaking the previous record of 4.031% on September 21.

The higher the yield, the lower the bond price. The bond yield and price move in opposite directions.

There was also a capital flight on the Korean stock market as investors now prepare for further tightening of monetary policy by the US Federal Reserve.

Kospi closes on September 26, 2023 (Courtesy of News1 Korea) Kospi closes on September 26, 2023 (Courtesy of News1 Korea)
The country’s benchmark index, Kospi, lost 1.3% to close at 2,462.97 on Tuesday.

“The rise in the 10-year U.S. Treasury yield has triggered a (new) taper tantrum,” said Park Sang-hyun, an analyst at Hi Investment & Securities Co. “All Korean stocks, bonds and currencies are faltering at the same time.”

The “taper tantrum” refers to the panic selling of U.S. Treasury bonds that caused their yields to rise in 2013 in response to the Fed’s signal to end its quantitative easing program.

Won under downward pressure

The outlook for the Korean currency is bleak amid expectations of a long period of high interest rates in the US, market analysts said.

Some even predict that the dollar/won will exceed 1,400 this year.

“The rise in U.S. Treasury yields, which has further weakened the value of the Korean won against the U.S. dollar, was triggered by expectations of prolonged higher U.S. interest rates,” said Kim Seung-hyuk, an analyst at NH Futures Co. “Oil prices .” are flirting with $100 a barrel, and the expected inflation rate is rising, creating upward pressure on the dollar index.”

Last week, the Fed kept interest rates in a target range of between 5.25% and 5.50%, but opened the door to at least one more hike by forecasting this year’s top benchmark federal funds rate at 5.6%.

US Federal Reserve Chairman Jerome Powell (File photo, courtesy Reuters, Yonhap)US Federal Reserve Chairman Jerome Powell (File photo, courtesy Reuters, Yonhap)
Policymakers also forecast a key interest rate of at least 5.1% at the end of 2024, compared to their previous forecast of 4.6%.

The dollar is also gaining strength as the risk of a government shutdown in the US grows after the world’s largest economy so far tabled a federal spending bill. Congress should pass the bill by October 1 to prevent a U.S. government shutdown.

Global ratings service Moody’s warned on Monday that the US could face a downgrade of its credit rating if Washington freezes. It gives the world’s leading economy a rating of “Aaa” and a stable outlook, the highest among the world’s three leading credit agencies.

A month ago, Fitch downgraded the US by one notch to AA+, the same rating S&P Global assigned in 2011.

Ties on the downward spiral

If the US credit rating is downgraded, US Treasury yields could rise further, setting the stage for the dollar to rise further.

At a time when other major currencies show no signs of recovery, investors are relying more on the greenback.

“Other economies like those in Europe that are struggling with the economic downturn cannot raise their interest rates like the United States,” said Shin Se-don, a professor of economics at Sookmyung Women’s University in Seoul. “Dollar/won could top 1,400 this year as investors believe the dollar is the only reliable currency.”

The Fed-triggered “taper tantrum” is taking its toll on Korean financial markets
Bond yields are also likely to continue rising.

“The 10-year U.S. Treasury yield would rise to the low 5 percent range,” said Moon Hong-cheol, an economist at DB Financial Investment. “Local (Korean) bond yields are also forecast to continue their upward trend.”

BOOK AT DILEMMA

If the U.S. interest rate is raised by another quarter of a percentage point this year, its gap with Korean borrowing costs could widen to a record high of 2.25 percentage points, as Korea’s interest rate is at 3.50%.

This would further accelerate capital outflows from Asia’s fourth-largest economy, pushing the won further lower.

To prevent capital flight, Korea’s central bank could consider another interest rate hike before the end of this year, a move doubted by market analysts given the country’s weak economic growth.

Another rate hike would delay a recovery in Korea’s economy, which would be hampered by already high interest rates, a weaker won, rising oil prices and sluggish exports.

The Bank of Korea’s next monetary policy meeting is scheduled for October 19.

Write to Do-Won Lim and Sin-Young Park at [email protected]
Sookyung Seo edited this article.

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