Korea markets melt as Fed officials foresee longer-than-expected high rates

South Korean financial markets lost ground on Wednesday with the 10-year government bond yield at a one-year high as US Federal Reserve policymakers expect interest rates to remain high for a long time, raising fears over increasing capital outflows from Asia’s fourth-largest economy.

The South Korean won currency hit an 11-month low, while the main stock market touched its weakest point in more than six months.

The government bond came under further pressure after the country failed to join the FTSE World Government Bond Index (WGBI), an elite bond index compiled by FTSE Russell.

The 10-year debt yield gained 32.1 basis points (bps) to end local trade at 4.351%, the highest finish since Oct. 19, 2022, according to the Korea Financial Investment Association. The highly liquid three-year bond rate and the five-year debt yield also rose 22.4 bps and 26.1 bps to 4.108% and 4.203%, respectively, their highest closes in 11 months.

FTSE Russell, a global index provider, said on Sept. 28 that it decided to keep South Korea on the watch list for potential inclusion in its FTSE WGBI, although the country’s authorities proposed initiatives to improve the market’s structure and the accessibility of local capital markets. The announcement came when the domestic financial markets were closed for a stretch of Korean holidays including the Chuseok mid-autumn harvest festival from Sept. 28 to Oct. 3.

“FTSE Russell will continue to gather feedback from market participants as the proposed reforms are implemented to assess the practical experiences of international investors against the requirements for a Market Accessibility Level upgrade,” it said in a statement.

The move is likely to reduce appetite for South Korean government bonds, further lifting their yields, especially if the country’s market reforms fail to satisfy foreign investors, analysts said.

“Any noise on the implementations of the government market measures or their delay will affect foreigners’ purchases of won-denominated bonds,” said HI Investment & Securities. “The impact of the absence of major buyers such as foreigners could be larger than expected when the South Korean treasury bond market remained under pressure from the surge in US Treasury bond yields.”

SOARING US TREASURY YIELDS

The US 10-year Treasury yield topped 4.8% on Tuesday to hit the highest level in 16 years, prompting expectations that the benchmark rate could test 5% in the near term.

Fed officials said that interest rates will likely stay high for a long time.

Atlanta Fed President Raphael Bostic said that he is comfortable with the fed funds rate in the current range of 5.25%-5.50%, the highest in 22 years while believing rates should be held at current levels well into next year.

Cleveland Fed President Loretta Mester said that she thinks another interest rate hike is on the table and warned that rates could be held higher for "some time."

“At this point, I suspect we may well need to raise the fed funds rate once more this year and then hold it there for some time as we accumulate more information on economic developments and assess the effects of the tightening in financial conditions that have already occurred,” Mester said.

US jobs openings rose more than expected in August, data showed, in another sign of a resilient economy, which points to the Fed keeping rates higher for longer.

TUMBLING WON, KOSPI

South Korean currency and stocks also tumbled on the day.

The won lost 1% to close the local foreign exchange market at 1,363.5 per dollar, the softest since Nov. 10.

The South Korean currency is likely to weaken further as Fed officials’ hawkish stance is expected to drive more foreign investors out of the country, analysts said.

“The won is likely to head to a support level of 1,400 as the dollar is expected to stay firm until year-end when the Fed may tweak its stance due to changes in US economic conditions,” said Kim Seung-hyuk, an analyst at NH Futures Co. in a note.

Traders, however, grew more cautious over possible currency intervention by foreign exchange authorities to stem the won’s weakness.

South Korea’s foreign exchange authorities warned of measures to support the local unit as its depreciation often boosts import costs, adding to inflationary pressure, which is predicted to undermine the central bank’s effort to stabilize prices.

“We will take market stabilization steps if necessary while closely monitoring domestic price variables and capital flow trends with special vigilance since the local financial and foreign exchange markets may become more volatile on changes in external conditions,” said Bank of Korea Senior Deputy Governor Ryoo Sangdai during the central bank’s meeting on financial markets.

Ryoo said external uncertainties increased as global bond yields jumped with the Fed predicted to maintain interest rates high for the longer term and oil prices kept elevating.

Some economists expected the BOK to raise borrowing costs in order to stabilize the won as another US hike will widen the interest rate differential between the two countries to a record high of 2.25 percentage points, given South Korea’s policy interest rate of 3.50%.

“The currency market is getting more unstable as the BOK is expected to keep the policy rate although the Fed keeps raising,” said Shin Se Don, an economics professor at Sookmyung Women’s University in Seoul. “The BOK must clearly indicate the possibility of a further hike through forward guidance.”

BOK Governor Rhee Chang-yong repeatedly said the central bank needs to leave the door open to raising the base interest rate by 25 bps, but financial market analysts and investors ruled out the possibility of a further tightening considering the slowdown in the economy.

South Korea’s main stock market Kospi lost 2.4% to close at 2,405.69, the lowest since March 21, as foreign investors extended their selling spree to a ninth consecutive session. They dumped a net 1.7 trillion won ($1.2 billion) worth of stocks on the bourse since Sept. 18, according to the Korea Exchange.

Write to Jin-gyu Kang, Do-Won Lim and So-Hyun Lee at josep@hankyung.com
 
Jongwoo Cheon edited this article.