US Inflation Expected at 4%... Bank of Korea Faces Deepening Dilemma

US Treasury Yields Surge One Day After FOMC
Domestic Inflation Concerns Relatively Lower
Complex Calculations Due to Real Estate Issues

[Image source=Yonhap News]

[Asia Economy Reporter Kim Eunbyeol] As U.S. Treasury yields surged again, the Bank of Korea's concerns have also grown. Until the previous day, Jerome Powell, Chairman of the U.S. Federal Reserve (Fed), made remarks aimed at stabilizing the market, leading to assessments that the central bank had "bought time to deliberate," but the situation changed within a day. The rise in long-term Treasury yields ultimately signals expectations of rising inflation, and not raising the benchmark interest rate could be interpreted as a declaration that "the central bank will remain passive despite inflation." Although Korea has maintained a low inflation trend and is not currently in a situation to worry about inflation, the calculation becomes more complicated due to Korea's unique issue of real estate.

According to the Bank of Korea on the 19th, the correlation coefficient between domestic government bond long-term yields and U.S. Treasury yields is around 0.9, showing a strong linkage with the U.S. This means that Korea is easily influenced by U.S. interest rates.

The Bank of Korea is internally communicating 24/7 to monitor the market. Officials from the financial market-related departments and the New York office operations desk communicate via messenger apps to monitor domestic and international markets in real time. This is to quickly grasp the movements in the U.S. Treasury market and the impact of rising U.S. Treasury yields on the domestic market. Foreign investors hold about 15% of Korean government bonds, and in other countries, the proportion is about 20-30%. When U.S. Treasury yields rise, foreign investors tend to sell off in other countries as well, showing similar trends.

In particular, the Bank of Korea is closely watching market experts' remarks that the timing of benchmark rate hikes may accelerate as inflation rises recently. Bill Gross, co-founder of PIMCO and known as the "Bond King," recently said in a Bloomberg TV interview, "Inflation could rise to 3-4%," and "Inflation will eventually force the Fed to end its accommodative policy." Ray Dalio, founder and co-Chief Investment Officer (CIO) of Bridgewater Associates, the world's largest hedge fund, also forecasted that "inflation will surge, causing the Fed to raise benchmark interest rates sooner than expected."

The Bank of Korea is perplexed by the Fed's departure from the tradition of "raising benchmark interest rates to curb inflation when prices rise." There are forecasts that the Bank of Korea will face serious dilemmas around the end of this year on whether to follow the U.S.'s new policy or to control inflation using traditional methods.

The government is also paying attention to economic recovery and inflation. The Ministry of Economy and Finance judged in its "Recent Economic Trends (Greenbook March issue)" that financial market volatility has increased due to inflation concerns. The phrase "continued uncertainty in the real economy," used for the past eight months, was omitted. If market interest rates continue to rise due to inflation concerns, the burden on companies and households that have borrowed to invest will inevitably increase.

Some countries have already raised interest rates due to the burden of high inflation. Brazil raised its benchmark interest rate by 75 basis points (1bp=0.01 percentage point) to 2.75% for the first time in over six years the day before. Investment banks (IBs) expect some emerging countries to start raising rates as early as the fourth quarter of this year. Russia and Malaysia are expected to raise rates in the fourth quarter of this year, and India, South Africa, Indonesia, and the Philippines are expected to raise rates in early next year.

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