Despite US-Korea Interest Rate Inversion, Exchange Rate Falls... Has US Economic Recession Begun?

Decline in KRW-USD Exchange Rate Despite US Giant Step
Dollar Weakness Amid Fed's Expected Rate Hike Slowdown
US Consecutive Negative Growth Raises Recession Concerns
But Biden, Powell, Yellen All Say "Not a Recession"
Widening US-Korea Interest Rate Gap May Shake Markets

On the morning of the 29th, the won-dollar exchange rate is displayed on the screen in the dealing room of Hana Bank in Jung-gu, Seoul. [Image source=Yonhap News]

Although the U.S. implemented a 'giant step' (raising the benchmark interest rate by 0.75 percentage points), causing the Korea-U.S. benchmark interest rates to invert, the won-dollar exchange rate showed some hesitation by falling below 1,300 won. This was because expectations spread that the U.S. Federal Reserve (Fed) might ease the intensity of future monetary tightening, leading to a weaker dollar. Accordingly, there is hope that the exchange rate can stabilize in the 1,290 won range, but since opinions differ on whether the U.S. will enter a recession, the possibility of increased volatility in the won-dollar exchange rate cannot be ruled out.

The won-dollar exchange rate closed at 1,299.1 won on the 29th. It opened at 1,295.5 won, down 0.6 won from the previous day, rose to 1,301.7 won during the day, but then fell back below 1,300 won. The exchange rate had been on a high-rise since surpassing 1,320 won earlier this month. This was due to strong dollar preference as the U.S. rapidly raised interest rates in response to inflation reaching its highest level in 40 years. When the U.S. raises interest rates, South Korea experiences a decline in the won's value due to foreign capital outflows, causing the won-dollar exchange rate to soar.

In particular, the Fed raised the benchmark interest rate by 0.75 percentage points from 1.50-1.75% to 2.25-2.50% at the Federal Open Market Committee (FOMC) meeting on the 27th (local time), resulting in an inversion where the U.S. benchmark rate became higher than South Korea's rate (2.25%). This inversion of Korea-U.S. benchmark interest rates is the first in about two and a half years since February 2020 and the fourth time in history. However, there was no sharp rise in the won-dollar exchange rate or capital outflows as feared. The KOSPI also continued its upward trend, supported by net purchases from foreigners.

This was influenced by growing expectations that the Fed would soon slow the pace of rate hikes. Fed Chair Jerome Powell said at a press conference following the FOMC regular meeting, "At some point, it may be appropriate to slow the pace of rate increases, but that point has not been decided." The market expects that as concerns about a U.S. recession grow, the Fed will find it difficult to continue raising the benchmark interest rate at the current pace.

Jerome Powell, Chairman of the U.S. Federal Reserve (Fed), is holding a press conference after concluding the Federal Open Market Committee (FOMC) regular meeting at the headquarters in Washington DC on the 27th (local time).
[Image source=Yonhap News]

In fact, on the 28th (local time), the U.S. Department of Commerce announced that the U.S. GDP growth rate for the second quarter was -0.9%, marking negative growth for the second consecutive quarter following -1.6% in the first quarter. Two consecutive quarters of negative growth are generally considered a 'technical recession.' Accordingly, CNN described it as "an unofficial but widely accepted symbolic threshold for defining a recession." The New York Times also stated that "businesses are retreating and growth is slowing."

However, many opinions suggest it is difficult to hastily conclude the Fed will slow its rate hikes since the U.S. government and Fed have not officially acknowledged a recession. While the U.S. has entered a technical recession, the official determination of a recession is made by the National Bureau of Economic Research (NBER). Chair Powell cited strong employment data at the press conference, saying, "I do not think we are in a recession," and President Biden, mentioning SK Group's investment plans in the U.S., said, "This situation does not look like a recession to me."

U.S. Treasury Secretary Janet Yellen also stated, "A recession refers to a broad and widespread weakening of the economy, which is not currently happening." If the Fed continues its steep rate hike policy, prioritizing price stability over recession concerns, the interest rate gap between Korea and the U.S. will widen further, causing the won-dollar exchange rate to surge and accelerating capital outflows. The Bank of Korea held a market situation review meeting after the FOMC and assessed that "uncertainty regarding the pace and magnitude of the Fed's rate hikes remains high, increasing the likelihood of volatility in global financial markets."

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