What to do after the rate reversal

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What to do after the rate reversal

The U.S. benchmark rate has become higher than Korea’s 2.25 percent after the rare back-to-back hike by the U.S. Federal Reserve last week placed the Fed fund rate range at 2.25 to 2.50 percent. The last time U.S. debt yielded greater than Korea’s was in February 2020.

The Fed last month raised the federal funds rate by 75 basis points for the second consecutive time to help contain runaway inflation. Fed Chair Jerome Powell indicated that the tightening pace could be moderated after another big increase in September.

The U.S employment market remains solid just as Powell denied the economy was receding despite a contraction in gross domestic product. The U.S. still has the leeway to increase rates without worrying about the impact on the economy.

But Korea does not have much maneuvering room left. Household debt remains colossal, with the bulk hinging on floating interest rates.

After delivering an unprecedented hike of 50 basis points in July, Bank of Korea Governor Rhee Chang-yong said that further increases need to be gradual, regardless of the bolder steps taken by the United State.

Given such circumstances, the gap between U.S. and Korean interest rates will stay wide for a considerable period of time. The relatively small open market will be susceptible to foreign capital flight.

U.S. rates were higher than Korea’s from June 1996 to March 2001, from August 2005 to September 2007, and from March 2018 to February 2020. The gap went as wide as 150 basis points from May to October in 2000. But a foreign capital exodus did not take place. Foreigners kept up their net investment in Korean stocks and bonds throughout those periods.

In an emergency meeting last Thursday, Deputy Prime Minister for Economic Affairs Choo Kyung-ho said the Fed’s latest move would have limited impact on Korean capital markets.

Panic is unnecessary for now, but authorities must not let down their guard. A strong U.S. dollar coupled with high interest rates has caused an outflow of foreign capital from emerging markets in the past. When or how emerging economies could shake cannot be known.

Foreign capital is more sensitive to a country’s economic fundamentals than to gaps between interest rates. It is important to give foreign investors the confidence in our economy management. The government must quicken the establishment of fiscal guidelines for our economy and carry out structural reforms in labor and pensions.

The foreign exchange regulations also should be eased to meet with global standards to raise the appeal of Korean assets and currency.
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