Only 3 Out of 10 Global Investment Banks Expect a U.S. Rate Hike This Year...Implications for Korea [BOK Focus]

U.S. Job Weakness and Relatively Stable Headline Inflation
Key Factors Lowering Chances of a Fed Rate Hike This Year

Consensus for at Least One More Rate Hike in South Korea, Two Hikes Possible
Korea-U.S. Rate Gap Could Shrink to -0.50%
Supply-Demand vs. Fundamentals: Currency Stabilization Expected
Caution Advised on Moves by "Seohak Ants"

Recently released key indicators suggesting a lower likelihood of a U.S. policy rate hike have drawn attention to their potential impact on South Korea. As South Korea is already in the midst of a rate-hiking cycle, further rate increases are expected "barring any extraordinary shock." If the hike reaches the upper end of market expectations, the South Korea-U.S. interest rate gap could narrow to minus 0.5 percentage points by the end of the year. In this scenario, structural fundamental factors are likely to outweigh short-term supply-demand variables that have shaken the foreign exchange market since the end of last year, contributing to currency stability. However, it remains to be seen whether the so-called "Seohak Ants"—Korean individual investors who invest overseas—will return their focus to foreign markets given the recent adjustment in the domestic stock market, which could become a new variable.

Will the U.S. Hike Rates This Year? Seven Major Investment Banks Say 'No'

According to the New York office of the Bank of Korea on August 13, as of August 7, only three out of ten major global investment banks predicted that the United States would raise its policy rate this year. JP Morgan brought forward its forecast for a rate hike by U.S. Federal Reserve (Fed) Chair Kevin Warsh and other FOMC members from September next year to December this year, citing mounting pressure within the FOMC for a hike. As a result, the number of institutions expecting a hike increased by one compared to the previous survey, but still remained at three. Of the remaining seven banks, six expected rates to be held steady while one anticipated a cut. While they assessed the likelihood of a rate hike had declined following last month’s FOMC meeting, they nonetheless pointed out that dissenting views in favor of a hike indicate persistent anxiety over inflation going forward.

U.S. employment figures released subsequently, as well as the July Consumer Price Index (CPI) published overnight, also pointed towards a reduced likelihood of further rate increases. The July U.S. CPI rose 3.4% year-on-year. This growth rate slowed from June’s 3.5% and matched expert forecasts compiled by Dow Jones. The core CPI, which excludes energy and food prices, climbed 2.5% on-year, also decelerating from 2.6% in June. With the U.S. consumer price inflation rate easing from 4.2% in May to 3.5% in June and then 3.4% in July, expectations for a Fed rate hold have strengthened.

Although markets currently see a good chance of a rate hold in the U.S. this year, experts note that future decisions will depend on international oil price trends arising from geopolitical risks. Hae Gun-hyung, an economist at Shinhan Investment Inc., remarked, "With July’s lackluster jobs data and a clear slowdown in the economic activity index, the risk of renewed demand-side inflationary pressure in the second half is weak." However, he cautioned, "There remains an upside risk to supply-side inflation due to the rebound in international oil prices in July, and if oil prices remain at current levels in August, there is still a chance consumer prices could rise again."

1–2 Further Rate Hikes Expected in South Korea, Interest Rate Gap Could Narrow to -0.5%

Conversely, in South Korea, the market expects at least one more base rate hike within the year. Depending on domestic and global developments, some market participants even anticipate a second hike in November, following another this month. Although all scenarios remain within the realm of possibility, if the U.S. were to hold rates steady throughout the year while South Korea raises its base rate by 0.25 percentage points twice, the current Korea-U.S. rate gap of minus 1.0 percentage point would shrink to minus 0.5 percentage points. This would be the narrowest gap since the U.S. implemented a "giant step" 0.75 percentage-point hike in October 2022, which then brought the gap to minus 0.25 percentage points that month. Typically, South Korean rates have remained higher than those in the U.S. due to differences in risk premium between the U.S. dollar, a key global currency, and the Korean won, categorized as an emerging market currency. However, following the Fed’s strong fight against inflation in 2022, the gap reversed, at one point widening to minus 2.0 percentage points.

The narrowing of the Korea-U.S. rate gap is seen as especially positive for alleviating downward pressure on the won. Bank of Korea Governor Rhee Chang-yong is closely monitoring how the reduced gap with the U.S. will affect Non-Deliverable Forward (NDF) trading, which had previously amplified volatility in the foreign exchange market. Since settlement in NDF transactions reflects the domestic and U.S. interest rate differential, a narrower gap would likely reduce demand to borrow won at lower rates and invest the proceeds at higher rates elsewhere, thus relieving downward pressure on the local currency. Furthermore, a reduced rate gap would also lower hedging costs for domestic investors when investing abroad.

However, the possibility that a turbulent domestic stock market could fuel a renewed surge in overseas investments by "Seohak Ants" remains a variable. In the second half of last year, capital outflows by residents, the Middle East conflict at the start of this year, and more recently, overseas investor rebalancing prompted by rising stock prices have each acted as short-term factors, intensifying the weakness of the won in relation to Korea's economic fundamentals. With supply-demand imbalances easing, the long-term outlook is that the exchange rate will ultimately be determined by economic fundamentals, including the Korea-U.S. interest rate differential, current account, and growth rate gap.

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