Powell’s ‘interest rate pivot’… Three cuts Expected Next Year
The U.S. central bank, the Federal Reserve System (Fed), has formalized a pivot (monetary policy shift), predicting an interest rate cut next year for the first time since beginning high-intensity tightening in March 2022. The global financial markets cheered the strong pivot signal of three interest rate cuts next year, with the US Dow Jones Industrial Average hitting an all-time high and the KOSPI also rallying upward.
On the 13th (local time), the Federal Reserve announced at the regular meeting of the Federal Open Market Committee (FOMC) that it would maintain the US benchmark interest rate at 5.25-5.5%. This is the third consecutive interest rate freeze. The market’s interest that day was the dot plot. The dot plot refers to the 17 FOMC members’ respective interest rate forecasts expressed by ‘dots’. Their median forecast for interest rates at the end of next year was 4.6% (4.5-4.74%), which is 0.75 percentage points lower than the current interest rate, suggesting that there could be three cuts of 0.25 percentage points each next year.
Federal Reserve Chairman Jerome Powell expressed optimism throughout the press conference, saying that the U.S. inflation rate had fallen faster than expected. He said, “It is time for (interest rate cut discussions) to begin to become visible,” and “It was also a topic of discussion at today’s (FOMC) meeting.” He also declared that the high-intensity tightening cycle had effectively ended, saying, “Interest rates have peaked or are close to it.”
The stock market rose vertically following the formalization of the Federal Reserve’s pivot, which raised a total of 5.25% points 11 times in 1 year and 9 months. The U.S. Dow rose 1.4%, breaking the 37,000 mark for the first time in history, and among large-cap stocks, both the S&P 500 and the Nasdaq index reached their highest since January of last year. On the 14th, KOSPI closed at 2,544.18, up 1.34% from the previous day. The won-dollar exchange rate also closed at 1,295.4 won, down 24.5 won.
The U.S. Federal Reserve’s (Fed) signal of a base interest rate cut is expected to somewhat alleviate the burden of the three biggest risks to the domestic economy: high interest rates, high exchange rates, and high inflation. This means that the interest burden on households and businesses, which is leading to a slump in domestic demand, can be reduced. However, experts believe that it is highly likely that the significantly high interest rate trend will continue next year as interest rate cuts will be limited to a small amount due to inflationary pressures. There are predictions that the Bank of Korea will also be able to begin a moderate interest rate cut only in the second half of next year (July to December).
The reason that KOSPI and KOSDAQ showed an upward trend of more than 1% on the 14th was largely due to the inflow of foreign investment funds as preference for risky assets increased due to the end of the US austerity policy. In fact, on this day, foreign investors purchased 620 billion won worth of stocks from KOSPI and 130 billion won worth of stocks from KOSDAQ. On this day, the won-dollar exchange rate plummeted (the value of the won soared) due to the weakening dollar and the inflow of dollars due to increased foreign investment. The market expects that the domestic stock market will show an upward curve for the time being as the preference for global risky assets becomes stronger.
Above all, an interest rate cut can provide breathing room for households and businesses struggling through the third crisis. In the aftermath of the recent decline in U.S. Treasury interest rates, the interest rate on 5-year bank bonds, which is the standard for fixed home mortgage loans, fell from 4.463% on the 14th of last month to 4.046% on the 13th of this month. If the price of imported goods falls due to a fall in the exchange rate, price pressure may be alleviated to some extent. The domestic consumer price inflation rate fell to 2.3% in July of this year, but rebounded to 3.8% in October due to the rise in the exchange rate.
Expectations for economic revitalization due to the Federal Reserve’s pivot (monetary policy shift) are growing, but experts are of the opinion that excessive optimism should not be tolerated. This is because, considering recent price trends such as increases in public utility rates, a significantly high interest rate trend is inevitable next year. Expectations that we can return to the old ‘zero interest rate’ era have no choice but to be abandoned for the time being. Park Chun-seong, director of the Macroeconomic Research Department at the Korea Institute of Finance, said, “Even if the U.S. base interest rate falls by 0.75 percentage points next year, it will still be at a high level of more than 4%.” He added, “Because interest rates will still be high next year, the interest burden will still be large.”
If high interest rates and high prices remain at a certain level next year, a prolonged domestic recession is expected to be inevitable. Additionally, some point out that there are concerns about a decline in exports because the Federal Reserve’s interest rate cut was premised on a slowdown in the U.S. economy. Jang Gyu-cheol, head of the Economic Forecast Department at the Korea Development Institute (KDI), said, “The U.S. monetary policy shift may help stabilize the domestic financial and foreign exchange markets, but it is difficult to have an immediate impact on the domestic economic rebound.” He added, “It will take the next year for the domestic economy to recover.” He predicted, “You will be able to experience it.”
The Bank of Korea’s dilemma of being unable to raise or lower interest rates for a while due to complex domestic and international economic situations is likely to be resolved with the Federal Reserve’s suggestion of an interest rate cut. However, because price pressures still remain, the prevailing view is that the Bank of Korea will only be able to cut interest rates after the second half of next year. Ha Jun-kyung, a professor at the Department of Economics at Hanyang University, predicted, “The interest rate gap between Korea and the United States is still large, so lowering it first will incur risks such as foreign investment withdrawal,” and predicted, “It is highly likely that the Bank of Korea will move after the Federal Reserve lowers the interest rate sometime next summer.”
The key to the timing and speed of the base interest rate cut is prices. When the Bank of Korea announced its revised economic outlook last month, it raised its forecast for the consumer price increase rate from 3.4% to 3.6% this year and from 2.4% to 2.6% next year. In the monetary and credit policy report distributed on this day, the Bank of Korea cautioned against the possibility of an immediate change in monetary policy, saying, “There are various uncertainties related to achieving the inflation rate target.” Lee Sang-hyeong, Deputy Governor of the Bank of Korea, also drew a line, saying, “It is not appropriate to mechanically link our monetary policy with our monetary policy just because the Federal Reserve’s monetary policy changes.”