Bracing for shocks from giant steps

The U.S. Federal Reserve has hit the pedal on monetary tightening by delivering its third straight rate hike of three quarters of a point to place the Fed fund’s rate at the range of 3 percent to 3.25 percent last week.

Although the move was widely expected, it nevertheless caused tantrums in financial markets across the globe. The Korean won-dollar exchange rate soared to 1,400 won per U.S. dollar. The won fell 1.11 percent last week to end at 1,409.70 won per dollar after going as low as 1,413.40 won during the day. The last time the exchange rate reached 1,400 won against the greenback was March 2009 amid the global financial crisis. Against January 2020, the won has lost more than 30 percent of its value against the dollar. The Kospi and Kosdaq were shaken as a result.

Worse, the tightening is hardly over. Fed Chair Jerome Powell said he will return the inflation rate to the 2 percent target.” The first priority is curbing the interest rate, he said.

Given his hawkish remarks, the Fed could raise the rate target by 50 to 75 basis points in upcoming rate-setting meetings in November and December. The Fed funds rate would reach 4.0 percent by the year end, much higher than the 3.4 percent expected earlier in the day. The Federal Open Market Committee (FOMC) is expected to put the year-end median target at 4.4 percent. The U.S. tightening policy could last longer than expected.

The repercussions on the Korean market could be damaging. The Bank of Korea (BOK) has raised its base rate for its fourth straight meeting, a first, last month. Still, the gap with the U.S. rates widened by up to a full percentage point after the latest U.S. step.

Korea cannot match the galloping pace of the U.S. as its household debt overwhelms the GDP with the fastest rise in the world. The unprecedented rate increases have caused a slump in the housing market and exacerbated borrowing cost for households. BOK Gov. Rhee Chang-yong hinted the rate increase could go beyond a quarter of a percentage at the possibility of taking a “big step,” or an increase of 75 basis points.

The sharp weakening in the won can add to the widening of the trade deficit. Korea is set to incur a trade deficit for the sixth month in a row this month for the first time in 25 years. Although the Yoon administration cannot fix the global strengthening trend in the dollar, authorities must not sit idle. President Yoon Suk-yeol must convene export promotion meetings to find ways to sustain exports. If trade deficit stretches, the won’s weakening would worsen and trigger a currency crisis for the country.