[Why&Next] Will the Sharp Rise in Won-Dollar Exchange Rate Recur?... Emphasis on Downward Stabilization

Largest Ever US-Korea Interest Rate Gap
Concerns Over Exchange Rate Rise Grow
US Tightening Nears End, Dollar Weakens
Banking Crisis Eases & China Economic Recovery
Experts Say "Likely to Fall to Mid-1200 Won Range"

The gap between the benchmark interest rates of the United States and South Korea has widened to a record 1.75 percentage points, raising concerns about a rise in the won-dollar exchange rate similar to the second half of last year. Foreign investors chasing higher yields may pull funds out of the domestic market, potentially fueling the exchange rate increase. However, experts emphasize that as the U.S. tightening cycle approaches its end and the U.S. dollar continues to weaken, coupled with expectations of an improvement in South Korea's trade balance in the second half of the year, the won-dollar exchange rate is likely to gradually stabilize downward. Although the won has shown a relatively weak trend against major currencies due to sluggish exports?the engine of the Korean economy?and concerns over fundamentals, the outlook for the second half of this year is expected to be different.

Looking at the volatility of major currencies against the U.S. dollar in April based on the Seoul Foreign Exchange Brokerage official exchange rates on the 8th, the won's depreciation stands out. The won depreciated by 2.7% against the U.S. dollar last month alone. This decline is larger than that of the Japanese yen (-0.8%), which maintains an ultra-low interest rate monetary policy, and the Chinese yuan (-0.5%). The won's depreciation was even more pronounced than the U.S. dollar index's fluctuation rate (-0.6%). Considering that the euro and the pound appreciated by 1.1% and 0.9% respectively against the U.S. dollar during the same period, the won's weakness is even more notable. Excluding the Russian ruble (-5.6%), which is under Western sanctions, the won experienced the largest depreciation among major currencies.

Seunghyuk Kim, a researcher at NH Futures, explained, "Typically, when the U.S. dollar weakens, the won-dollar exchange rate falls, but last month it did not follow the dollar's decline." He added, "The won's relative weakness deepened due to growing fundamental concerns amid continued export sluggishness." The current account deficit recorded consecutive monthly deficits for the first time in 11 years in January and February, and the ongoing decline in exports and trade deficit led to domestic economic concerns, which translated into exchange rate increases. In fact, on the 27th of last month, the won-dollar exchange rate hit a new high for four consecutive trading days, soaring to 1,342.9 won during intraday trading.

FOMC Concerns Eased: "Downside Testing Will Continue"

In particular, the recent high-level trend of the won-dollar exchange rate was largely driven by heightened market caution ahead of the U.S. Federal Open Market Committee (FOMC) meeting on the 3rd of this month (local time). The Bank of Korea's Monetary Policy Committee held the benchmark interest rate steady twice last month, raising concerns about further widening of the interest rate gap with the U.S. The maximum interest rate differential reversal between South Korea and the U.S. before this tightening cycle was 1.5 percentage points from May to October 2000. That 1.5 percentage point gap lasted for 142 days. During this tightening cycle (since July 2021), the rate differential reversed by 1.5 percentage points from March this year until early this month, and on the 4th, the U.S. Federal Reserve's rate hike pushed the gap to a historic high of 1.75 percentage points. Jung-sik Kim, Emeritus Professor of Economics at Yonsei University, diagnosed, "With expectations of additional U.S. rate hikes early this month, concerns about the widening interest rate differential with the U.S. coexisted, and the market preemptively reflected this, leading to an increase in the exchange rate."

Another reason for the rise in the won-dollar exchange rate despite recent dollar weakness can be found in supply and demand factors such as dividend repatriation. Korean companies mainly pay dividends in April, and foreign investors convert the dividends they receive into dollars and remit them back to their home countries, which has contributed to the exchange rate increase. Following the global liquidity crisis triggered by events such as the U.S. Silicon Valley Bank (SVB) incident, risk aversion has spread, reducing the incentive to buy the won in financial markets classified as emerging markets, which has been a major factor behind the won's depreciation.

[Image source=Yonhap News]

Changseop Oh, a researcher at Hyundai Motor Securities, said, "Most of the foreign investors' dividend repatriation demand was completed by early May," and added, "With the Fed raising rates by 0.25 percentage points as expected and signaling a possible pause in rate hikes, tightening concerns have dissipated and uncertainty has been resolved." He forecasted that the won-dollar exchange rate will continue to test the lower bound toward the previous level of 1,180 to 1,200 won.

Experts expect that as the banking crisis triggered by the SVB incident gradually subsides and China's economic recovery spreads from the service sector to manufacturing in the second half of the year, the won-dollar exchange rate will gradually stabilize downward. In fact, although the Korea-U.S. interest rate gap widened to a record high on the 4th, the won-dollar exchange rate closed at 1,322.8 won, down 15.4 won from the previous day, showing signs of stability. On the same day, the won-dollar exchange rate opened at 1,320.0 won, down 2.8 won, and showed a limited downward trend. This was influenced by strong U.S. employment data and Apple’s earnings surpassing market expectations, which improved investor sentiment.

Won Joo-won, head of economic research at Hyundai Research Institute, expressed hope that "as the trade deficit decreases and turns into a surplus, the won-dollar exchange rate will stabilize downward toward the high 1,200 won range." Chanhee Kim, a researcher at Shinhan Investment Corp., predicted, "As factors that controlled the won-dollar decline are sequentially resolved after mid-second quarter, the exchange rate will again show a trend synchronized with the dollar index." Bank of Korea Governor Changyong Lee also stated in an interview with CNBC ahead of the Asian Development Bank (ADB) annual meeting opening ceremony held on the 3rd at Songdo Convensia in Incheon, "We are paying close attention to the increased volatility in the foreign exchange market," but "considering the outlook for U.S. monetary policy, the pressure on the won's depreciation will weaken."

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