[Dollar Dominance]③ Growing 'Tightening Spasm' Amid Strong Dollar... Exchange Rate Nears 1400 Won · US Treasury Yield Approaches 5%

The value of the dollar has soared amid expectations that the U.S. Federal Reserve's (Fed) tightening will be prolonged, intensifying a triple-weakness phenomenon where the Korean won, bonds, and stock prices all decline simultaneously. With the domestic economic recovery still sluggish, concerns are rising that if the exchange rate and government bond yields continue their high-level surge, it will not only significantly increase funding costs for companies and households but also negatively impact exports, inflation, and domestic demand, affecting the overall economy.

Exchange Rate Hits New High, KOSPI Falls... Helpless Against U.S. Tightening

According to the financial and foreign exchange markets on the 4th, during the Chuseok holiday when the domestic stock market and Seoul foreign exchange market were closed, the dollar value hit a new high, and U.S. Treasury yields reached their highest level since 2007, increasing the burden on the domestic economy. The Dollar Index, which measures the value of the dollar against six major currencies, surpassed the 107 mark, continuing the 'dollar dominance,' while the 10-year U.S. Treasury yield, a benchmark for global bond yields, rose above 4.8% annually, reaching the highest level in 16 years.

The Fed's tightening monetary policy and strong dollar are having an immediate impact on the domestic economy. On the morning of the same day in the Seoul foreign exchange market, the won-dollar exchange rate opened at 1,360 won, up sharply by 10.7 won from the previous trading day, and during the session rose to 1,361.7 won, breaking the previous high in just one trading day. Market analysts suggest that with rising international oil prices and continued weakness in Asian currencies, the won-dollar exchange rate could rise to between 1,370 and 1,380 won in the short term. If the Dollar Index breaks through the 108 mark, there is also a possibility that the exchange rate could surge to around 1,400 won, similar to the end of last year.

The domestic stock market is also weak. On the morning of the same day, the KOSPI fell more than 2% from the previous close, fluctuating around the 2,410 level, and the KOSDAQ dropped nearly 3%, struggling around the 810 level. Domestic government bond yields are also expected to face upward pressure as they are influenced by U.S. Treasury yields. Since bond yields and prices move inversely, rising yields mean falling bond prices.

[Image source=Yonhap News]

Bank of Korea: "Heightened Vigilance... Market Stabilization Measures if Necessary"

As the situation in the U.S. became serious, the Bank of Korea held a market situation review meeting chaired by Deputy Governor Yoo Sang-dae on the morning of the same day to assess the impact on domestic financial and foreign exchange markets. At the meeting, Deputy Governor Yoo stated, "With the increasing possibility of a prolonged high-interest-rate stance by the U.S. Fed, global bond yields have risen significantly," adding, "Domestic financial and foreign exchange markets may also experience increased volatility due to these external conditions, so we will maintain heightened vigilance, closely monitor domestic price variables and capital flow trends, and take market stabilization measures if necessary."

The Bank of Korea's mention of market stabilization measures underscores the severity of the triple-weakness phenomenon in the won, stock prices, and bonds caused by the strong dollar. Park Sang-hyun, a researcher at Hi Investment & Securities, explained, "The domestic financial market is already experiencing a triple weakness," and added, "It is still uncertain whether the 'tightening shock' risk from the September U.S. Federal Open Market Committee (FOMC) meeting will materialize or spread, but if U.S. Treasury yields rise further, the risk of a tightening shock could become more apparent."

A tightening shock refers to a situation where the U.S. tightening causes the currencies and stock markets of surrounding countries to plummet. A representative example is the tightening shock experienced in May 2013 when then-Fed Chairman Ben Bernanke hinted at ending quantitative easing as the economic recovery became clearer, causing global financial markets to suffer. Although the situation is not identical since the U.S. benchmark interest rate was near 0% in 2013 and is now at 5.5%, considering the recent sharp rise in international oil prices and the negative impact of China's economic slowdown, the tightening shock could worsen.

Concerns Over 'Cash Flow Blockage' for Households and Companies... High Interest Rates to Continue

Projections that the U.S. tightening stance will not ease anytime soon support this analysis. Last week, there were analyses suggesting that the Fed's tightening stance might weaken due to concerns over a U.S. federal government shutdown (temporary work stoppage), but on the 30th of last month (local time), a temporary budget bill was passed by the U.S. Congress in a dramatic move, removing factors that could constrain the Fed's tightening. Additionally, the U.S. manufacturing Purchasing Managers' Index (PMI) for September was 49, exceeding market expectations of 47.7, and Fed officials including Chairman Jerome Powell have repeatedly mentioned price stability, strengthening expectations for prolonged tightening.

If the strong dollar and rising Treasury yields continue, domestic government bond yields and loan interest rates will also rise, potentially worsening the 'cash flow blockage' for households and companies. For companies, increased government and corporate bond yields will raise funding costs, inevitably hurting profitability. According to the Bank of Korea, as of last year, financial institution borrowings by 'long-term persistent marginal firms' in Korea amounted to 50 trillion won, so liquidity crises could grow among highly indebted and low-credit marginal firms, spreading burdens to financial institutions. Particularly, Korea has the fastest-growing household debt relative to GDP at 108.1% globally, so households could also face significant shocks from high interest rates.

Kim Jeong-sik, emeritus professor of economics at Yonsei University, said, "If high interest rates persist, delinquency rates will rise, increasing financial distress and potentially accelerating economic recession, which could lead to a sharp drop in stock prices." He added, "U.S. economists had already predicted at the beginning of the year that high interest rates might last long, but Wall Street was too optimistic and only recently revised its outlook, causing a greater shock." The Korea Center for International Finance emphasized on the same day, "Structural changes are occurring in the government bond market due to the persistence of high inflation and the outlook for prolonged high interest rates," adding, "This also affects the stock market."