The U.S. Federal Reserve held its benchmark interest rate steady on the 29th, but markets were sharply shaken. That day, the yield on the 30-year U.S. Treasury bond broke through 5.2 percent, hitting its highest level since 2007. The Fed has now held rates for the fifth consecutive time this year, but the market focused on hawkish signals rather than the rate freeze itself. At the Federal Open Market Committee (FOMC) meeting, three members simultaneously called for a rate hike and cast dissenting votes, the first time this has happened since September 2016. This means the inflation risk and policy uncertainty that come with holding long-term Treasury bonds to maturity have grown that much larger.
The rise in U.S. long-term Treasury yields results from a combination of factors: expanded bond supply driven by accumulating fiscal deficits, rising market interest rates, an economic slowdown, and financial instability. It also reflects market distrust that, even if the central bank can control short-term rates, it will be unable to prevent inflation and widening fiscal deficits. When long-term Treasury yields rise, corporate investment and household consumption contract, and asset markets such as the stock market face greater pressure. If investors can expect returns of more than 5 percent annually from U.S. Treasuries, a safe asset, funds that had remained in risk assets are likely to move back to the United States.
The problem is the shock this will deliver to Korea's financial markets and macroeconomy. If foreign capital flows out of an already fragile domestic stock market, volatility will grow further, and the exchange rate is highly likely to face renewed upward pressure. If a rising exchange rate pushes up import prices, inflationary pressure could intensify further. The Bank of Korea, too, will have no choice but to accelerate rate hikes. For now, the U.S. rate freeze has eased the burden of a widening Korea-U.S. interest rate gap, but the rise in long-term Treasury yields is a clear signal that the market is pricing in the possibility of further U.S. rate hikes.
At times like these, the government's crisis management capacity matters all the more. Yet it is doubtful whether a government that has been wavering even in its response to stock market volatility and debt management can properly prepare for the approaching storm. Rather than shirking responsibility over the leverage problem cited as a cause of the stock market plunge and offering only stopgap remedies, the government must present fundamental measures to encourage long-term investment. A balanced response is also required, one that strengthens risk management over leveraged trading and excessive debt while not stifling corporate financing. Instead of resting on optimism riding on the semiconductor boom, the government must coolly examine the shock that changes in the external financial environment will bring and prepare preemptively. Now is precisely the time for the government's economic team to prove its crisis management capabilities.
