Volatility Likely to Increase in 'US Fed-Market Tug of War'... BoK and Government Strengthen Monitoring (Comprehensive)

Indicated Base Rate Freeze Until 2023, but
Market Still Skeptical... Financial Market Volatility Expected to Increase This Year

BOK Holds 'Situation Review Meeting'... "Cannot Rule Out Increased Volatility"
Deputy Minister of Economy & Finance: "Closely Monitor Market Trends, Ensure Market Stability"

Lee Seung-heon, Deputy Governor of the Bank of Korea (left), and Kim Yong-beom, First Vice Minister of Strategy and Finance [Image source=Yonhap News]

[Asia Economy Reporter Kim Eun-byeol] Although the U.S. Federal Reserve (Fed) announced that it would not raise the benchmark interest rate, which was lowered to zero in response to the COVID-19 shock, until 2023, market skepticism remains. As the Fed and the market engage in a tug-of-war, causing sharp fluctuations in government bond (market) yields, concerns are emerging that financial market volatility may increase going forward.

On the 18th, Kim Yong-beom, the 1st Vice Minister of Strategy and Finance, convened a meeting immediately after the Fed's March Federal Open Market Committee (FOMC) and said, "Given the possibility that financial market volatility, including rising U.S. government bond yields, may persist depending on economic indicators and policy responses, we must closely monitor market trends." He added, "Please also make every effort to stabilize the market so that volatility does not expand amid supply and demand pressures in the government bond market." The Bank of Korea (BOK) also held a situation review meeting chaired by Vice Governor Lee Seung-heon and stated that it cannot rule out the possibility of increased volatility in domestic and international financial markets.

Attention is focused on the timing of monetary policy normalization due to rising market interest rates and the Fed's response. The day before, Fed Chair Jerome Powell stated that the zero interest rate would be maintained until economic normalization is confirmed through indicators, calming the bond market for the time being. The yield on the U.S. 10-year Treasury bond, which had surged to 1.689%, fell to the 1.64% range after the FOMC, and domestic government bond yields also showed a slight decline, mainly in short-term bonds. However, the market is expected to remain skeptical until confidence in Chair Powell's remarks is established.

Goldman Sachs evaluated, "In a situation where macro indicators such as employment show strong momentum, it will be difficult to suppress the market from moving ahead of the interest rate hike path suggested by the Fed." JP Morgan also stated, "Although the Fed signals a rate freeze, this alone may not guarantee long-term interest rate stability amid fiscal expansion and inflation risks."

In the domestic market, including the BOK, it is difficult to predict the timing of rate normalization prematurely. However, inflation is rising, and the side effects of ultra-low interest rates, such as rapid increases in real estate prices, are significant. Factors determining the timing of rate normalization include whether herd immunity is formed by the end of this year through rapid vaccination and how much inflation levels exceed expectations.

In last month's BOK Monetary Policy Committee minutes, some members expressed hawkish (monetary tightening) views. One member said, "Potential factors threatening future financial stability are accumulating, such as rapidly increasing household debt, expanding corporate credit, and continuously rising real estate prices," and added, "Once the economy enters a full recovery phase, it is necessary to consider monetary policy operations that emphasize financial stability." Another member said, "There is a view that low interest rates hinder restructuring, damaging the mid- to long-term economic growth foundation and possibly negatively affecting employment." However, the Monetary Policy Committee has unanimously kept the benchmark interest rate at a record low of 0.50% annually, considering the COVID-19 shock.

There is also a precedent in 2010, right after the financial crisis, when Korea raised interest rates before the U.S., considering inflationary pressures. At that time, while the Fed maintained the benchmark rate at zero, the BOK adjusted the benchmark rate from 2.00% to 3.25% in five steps over about a year starting in July 2010.

Within the Fed, the number of people who think the zero interest rate policy should be changed next year given the current pace of economic recovery and inflation is increasing. According to the dot plot released by the Fed after the FOMC, the number of members who expect a rate hike next year rose from 1 to 4 out of 18 at the end of last year. The number of members forecasting a rate increase in 2023 also changed from 5 to 7. The dot plot is an indicator showing FOMC members' future interest rate outlook.

On the same day, the Central Bank of Brazil raised its benchmark interest rate by 0.75 percentage points from 2% to 2.75%, a larger-than-expected increase. This is because inflation, which recorded 4.52% last year, continues to rise this year. Experts say that as economic optimism expands centered on the U.S., market interest rates rise, and emerging countries, despite debt burdens, may need to raise rates first. Along with Brazil, Turkey, Nigeria, and Argentina are considered countries likely to implement rate hikes within this year.

This content was produced with the assistance of AI translation services.