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"I need to get 30,000 won for naengmyeon"... accelerating inflation
Last weekend, after a long family outing to the Blue House, I visited the Pyongyang Naengmyeon restaurant above the Sajik Tunnel in Seoul.
The price of a bowl of naengmyeon written on the menu is 16,000 won, and I asked the owner of the naengmyeon restaurant if the price was right these days, but the price has gone up a lot.
The owner, who lived in Pyongyang and settled down with the whole family except for her husband, said, "To meet the balance, you have to pay 30,000 won for a bowl of naengmyeon. Even if the price rises, it doesn't fit. The cost of materials and labor has gone up too high. Working people ask for more than 200,000 won a day. I don't think it's okay to suddenly raise the price of naengmyeon, so I wait until everyone else raises it, and then raise it when I can't help it."
In August, Korea's consumer price index increased by 5.7%, down 0.6 percentage points from the July inflation rate of 6.3%.
This is due to the slowdown in energy price growth as international oil prices fell from the previous month.
Although the inflation rate has slowed somewhat, it is still nearly three times higher than the Bank of Korea's target of 2%.
Excluding food and petroleum products, which fluctuate in price, the core price index also rose by 4.4%, and consumers' expected inflation rate one year later also stood at 4.3%.
If the inflation sentiment spreads and service rates rise, it is impossible to guarantee price stability in the future.
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The rise in domestic consumer prices is due to the poor harvest of domestic agricultural products, but the rise in raw material prices, on which we mostly depend on imports, and the steeply rising exchange rate are contributing to this.
The won-dollar exchange rate has risen by 200 won per dollar this year.
The Bank of Korea is using its current foreign exchange reserves of 430 billion dollars to throw a so-called 'lunch bomb' to stop the rate of increase in the exchange rate.
It is known that the won-dollar exchange rate of 1,400 won is the final line of defense, and the dollar is released so that it does not cross that line.
If the trade deficit continues for four months in a row, foreign stocks are sold, domestic institutional investors buy foreign stocks, and even foreign bond investment funds leave in earnest, the exchange rate could rise even more.
If the US raises the base rate by more than 0.75%p on the 21st of this week, and the interest rate gap between Korea and the US widens, some predict that it will be difficult for the Bank of Korea to defend the exchange rate defense line.
As of the end of August, Korea's foreign exchange reserves stood at $436.4 billion, down $32.8 billion from $469.2 billion at the end of October last year.
As of the end of last month, foreigners held 862 trillion won in domestic stocks and bonds, and net sold 15 trillion won in stocks this year, while net buying 10 trillion won in bonds.
If the interest rate gap between Korea and the US widens, there is a concern that foreign investment funds may flow out in earnest.
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America, another giant step this week... Korea-US interest rate gap widening to 100bp?
The US central bank, the Federal Reserve (Fed), will hold the Federal Open Market Operations Committee (FOMC) on the 20th and 21st this week to determine the benchmark interest rate.
The US financiers, who had originally predicted a 0.5%p increase, are now making the base rate increase by more than 0.75%p a reality.
There is even a forecast that the company will go beyond the giant step of a 0.75%p increase to an ultra-step of a 1%p (100bp) increase.
Despite the drop in international oil prices, the US CPI rose 8.3% in August, a slight decline from 8.6% in July.
Excluding food and petroleum, the core price index rose to 6.3%, up from 5.9% in the previous month.
As inflation did not subside, voices calling for a 1%p rate hike all at once in order to meet inflation expectations were raised.
Economists in the United States are also arguing that the Fed will raise interest rates two more times following the rate hike in September, raising the base rate to close to 4.5% by the end of the year.
In August, the Bank of Korea raised the base rate by 0.25 percentage points to 2.5%.
The benchmark interest rate, which was temporarily lower than the US, was adjusted to 2.5% per annum, the same as the US.
The Bank of Korea Governor Chang-yong Lee announced a 'baby step' of a 0.25 percentage point increase in the base rate, saying, "Even if Korea's base rate is lower than that of the US for the time being, the outflow of foreign investment will not be large."
In the past three times, Korea's base rate was lower than that of the US, but the outflow of foreign investment funds was not large, and there was a net inflow of foreign investment funds.
However, the US Federal Reserve is expected to continue raising interest rates until at least the first half of next year, following an increase of 0.75 percentage points or more on the 21st.
If the Bank of Korea, which has two MPCs left until the end of this year, continues the baby step of raising the interest rate by 0.25%p, the interest rate gap between Korea and the US, which is 0.75% this month, will widen further and the interest rate inversion will be prolonged.
Now, unlike in the past, the dollar continues to strengthen around the world, and even Korea's trade balance is running in a deficit, raising concerns that foreign investment funds may deviate significantly.
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Bank of Korea, "Capital outflow is not large even if interest rates are reversed" vs "It is different now. Don't be vigilant"
In a 'Monetary and Credit Policy Report' submitted to the National Assembly on the 8th, just before the Chuseok holiday, the Bank of Korea said, "There is a need to continue the trend of rate hikes. The extent and speed of interest rate hikes depend on the extent and speed of high inflation, the flow of economic growth, and capital. We will make a decision while closely examining inflows and outflows, financial stability, monetary policy changes in major countries, and geopolitical risks,” he said.
Unless special circumstances arise, it will continue to raise the interest rate slightly as it is now.
In the Monetary and Credit Policy Report, the Bank of Korea reviewed the 'Effect of the inversion of the policy rate between Korea and the US on the flow of foreign securities investment funds' 1) June 1999 to March 2001 2) August 2006 to 2007 September 3) During the three inversions of the Korea-US base rate from March 2018 to February 2020, it was revealed that the outflow of foreign investment funds was minimal or rather a net inflow.
It also pointed out the fact that foreign bond investment funds flowed considerably during the second and third inversions of the Korea-US interest rate.
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However, the current economic situation is different from the past, and there are voices that it is impossible to predict the movement of foreign investment funds in the future based on a flat analysis of past cases.
In a situation where interest rates are rising steeply in Europe as well as the United States, if the interest rate gap between Korea and the US widens and the interest rate inversion period is prolonged, foreign investment funds will have no choice but to escape.
Lee Seong-hee, former head of the Seoul branch of JP Morgan Chase Bank, said, "Korea's economic situation was relatively good, and it is different from the past when interest rates were raised gradually. Now, the US is expected to raise interest rates steeply for a long time. One-time rate inversion. If the interest rate inversion continues, it is a different story. When the economy is good, raising interest rates raises stock prices. Conversely, when interest rates are raised when the economy is unstable, funds move from stocks to bonds. When I do, of course, I go to the United States,” he said.
The rationale for the Bank of Korea's belief that securities investment funds will not diverge significantly even when interest rates are reversed is the net inflow of 10 trillion won in bond investment funds, unlike the 15 trillion won in stock investments this year and until last month.
Lee Seong-hee, former branch manager, said, "80% of the remaining bond investment funds in Korea are arbitrage funds. These funds are exchanged with domestic banks to buy KRW in dollars when they enter Korea. , if it is difficult to obtain a dollar, domestic banks increase the interest rate against the dollar during a foreign exchange swap, so if the interest rate difference is small, domestic inflows will increase. "If the situation worsens, even if there is a loss, the bonds are sold before maturity," he said.
In fact, the amount of domestic bond holdings held by foreign investors, which has continued to increase, has decreased by 1.8 trillion won over the past month.
The same goes for foreign central banks, which account for about 20% of foreign bond investment.
The Bank of Korea said that foreign central banks' bond investment increased when interest rates were inverted in the past, but that is when the won strengthened in the past, but it is different during the dollar strength period like now.
Analysts say that the bond investment funds held by central banks to diversify their foreign exchange reserves do not aim for foreign exchange gains, but they will repay the bonds when they mature when they judge that the economic situation is bad.
As Templeton Asset Management, which was once a big player in domestic bond investment, withdrew, it is known that there are few domestic bonds held by active funds aimed at interest rate gains and foreign exchange gains at the same time.
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"Tangled foreign exchange supply and demand, the sentiment of the exchange rate rise is a problem"... A holistic response strategy is urgently needed
When the won-dollar exchange rate was threatened at the 1,350 won level, which was considered a psychological barrier, President Yoon Seok-yeol said in a briefing on his way to work on the 23rd of last month, "I think the public will be very worried about the exchange rate that has soared to 1,340 won. Currency of strong dollar and weak won We will do our best to manage risks through emergency economic countermeasures meeting so that the situation does not have a negative impact on our market.”
However, the won-dollar exchange rate rose to 1,354 won on the first day of September, breaking through the 1,350 won range and rising to 1,390 won on the 14th, threatening the 1,400 line.
There is also a forecast that if the 1,400 won line is broken, it will rise sharply to 1,500 won.
There are also concerns that if the US Federal Reserve takes another giant step on the 21st, US time, the exchange rate may rise further along with a decline in stock prices.
The problem is that the recent exchange rate rise is caused by the basic increase in demand for the dollar rather than speculative factors.
As the trade deficit continued for four months in a row, demand for payment continues, and the demand for dollars for overseas investment is not declining.
There is also concern that the shipbuilding industry, which is receiving large-scale orders as the dollar drought continues, will have difficulty finding financial institutions to buy forward exchanges.
Another problem is that it is impossible to control the exchange rate by raising interest rates alone amid a strong global dollar.
The volume of foreign exchange transactions in the world is estimated to reach $2 trillion per day, but the volume of foreign exchange transactions in Korea is only about $10 billion per day.
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Lee Seong-hee, former head of the Seoul branch of JP Morgan Chase Bank, said, "Basically, there is a lot of demand for dollars, but there is a factor in the exchange rate. The demand for dollars from companies continues, but the Bank of Korea is passively intervening, and domestic pension funds such as the National Pension Service and institutional investors invest in overseas securities. When they intervene in the foreign exchange market, they intervene boldly, and when domestic institutional investors invest in foreign stocks, they do not hedge against foreign exchange as they do now and do not just buy dollars, but do currency hedging. A policy change is needed to control the supply and demand of dollars by selling forward exchange for overseas investment funds and to obtain foreign exchange gains.”
In general, when a shock occurs in the global financial market in a situation where foreign assets are hedged against foreign exchange risk, the price of overseas investment assets decreases and the dollar-won exchange rate rises according to the preference for safe assets.
In this case, a double loss occurs due to the mismatch between the change (decrease) of foreign currency assets and the foreign currency liabilities (fixed) of the forward exchange (oversold position of the forward exchange position) along with the valuation loss in overseas investment assets.
Macro hedging is an aggressive foreign exchange risk management technique that seeks both investment returns and foreign exchange gains by investing without open fx risk for the purpose of avoiding this and maximizing profits.
This is the method used by aggressive hedge funds or active funds.
If you invest overseas without hedging foreign exchange like this, it will only induce purchase demand to buy dollars, which will further increase the exchange rate.
On the other hand, as much as you buy dollars for overseas investment, if you sell a forward exchange in advance or hedge the currency through a foreign exchange swap, it will not affect the supply and demand of dollars.
Lee Seong-hee, former head of JP Morgan's Seoul branch, said, "The current strategy of the National Pension, a public fund, is further weakening the won due to the continued large-scale demand for dollars and aggravating domestic macroeconomic instability. hedge)' strategy seems to have succeeded to some extent so far, but I think now is the time to give an appropriate flexible dynamic macro hedging strategy to foreign exchange risk management from a macro and long-term perspective. If asset investment is implemented through swap rather than a no-hedge strategy, and foreign exchange gains are realized by selling forward exchanges in some portfolios that have not been hedged in the past (supply of forward exchanges is the supply of foreign exchange like the supply of spot exchanges), the National Pension Service The forward exchange supply of the National Pension Service is expected to help relieve the foreign exchange market instability and stabilize macroeconomic conditions by suppressing a further sharp rise in the dollar-won exchange rate, he said.
As of the end of June, the size of the National Pension Service was 882 trillion won, of which 34%, or 300 trillion won, was invested in overseas stocks and bonds.
If the National Pension Service and domestic institutional investors respond flexibly to the movements of the global financial market, they can reap foreign exchange gains and contribute to the stability of the financial market.
It can also prevent foreign currency investment losses that may occur if the exchange rate declines at a certain point in the future.
It is time for the government and the Bank of Korea to not only shout the financial market with words, but to take active measures to solve the supply and demand in the market.
Neither of the accelerating pace of US Federal Reserve tightening, the escalating war between Russia and Ukraine, and the deepening economic slump in China, which the Bank of Korea suggested in its Monetary and Credit Policy Report as a factor of uncertainty, shows any signs of progressing in the right direction.
It is time to listen to the market and take action rather than relief.