The Bank of Korea Says "Even if US High Interest Rates Persist, Won-Dollar Exchange Rate Volatility Will Not Be Significant"

[Image source=Yonhap News]

The Bank of Korea stated, "There is an increased likelihood that the recent high interest rates in the United States will persist for a long period," but also noted, "Compared to last year, the anxiety in international financial markets has lessened, and the supply and demand situation for the US dollar in the domestic foreign exchange market has improved, so the volatility of the exchange rate is expected to be less severe than feared."

Park Byung-geol, Deputy Director of the International General Team at the Bank of Korea's International Department, and researcher Lee Han-sae explained on the 7th in a blog post titled 'Despite the possibility of prolonged high US interest rates, the foreign exchange market is more stable than last year' that "Since 2014, South Korea has become a net external asset country with more external financial assets than financial liabilities, so it can sufficiently absorb shocks even if the exchange rate rises to some extent."

Deputy Director Park first predicted that the US high interest rate trend could continue for a long time. He pointed out, "The US Treasury yield (10-year basis) rose sharply from 3.96% at the end of July to 4.95% on the 10th of October," adding, "Considering that this was largely due to factors such as the deterioration of Treasury supply and demand conditions, which are difficult to resolve in the short term, there is a possibility that the US high interest rates will persist for a long time."

He further explained, "Breaking down the factors of the rate increase through the Federal Reserve's quantitative model, the rise in the term premium, which reflects compensation for long-term bond holding, was greater than last year," and analyzed, "It is estimated that the uncertainty in the supply and demand of US long-term Treasury bonds increased due to the Fed's reduction of bond holdings, the Treasury's expansion of bond issuance, and the reduction in investment demand for US Treasuries from overseas investors such as China, which manifested as an increase in the term premium."

He explained that even if the Fed begins to lower policy rates after next year, the pace is likely to be very gradual. Deputy Director Park said, "Easing the heightened inflation expectations following the COVID-19 pandemic and the Russia-Ukraine war has emerged as a major task for central banks of major countries," and added, "The Fed is also emphasizing its strong commitment to bringing the inflation rate back to 2%."

Although US interest rates are at a higher level than last year and are expected to persist for a considerable period, recent financial market anxiety is less than it was in September-October last year.

Deputy Director Park noted, "The market's expectation that the Fed's policy rate hike cycle is coming to an end seems to have greatly contributed to alleviating anxiety," and pointed out, "Looking at the four previous US monetary tightening (rate hike) cycles, US Treasury yields generally declined after the policy rate peaked, although the speed varied."

In particular, unlike last year when concerns about a global economic slowdown were high, the recent increased expectations for a soft landing of the US economy are also interpreted as contributing to the stabilization of investor sentiment. While regions outside the US, such as the Eurozone, are experiencing economic sluggishness, the US shows favorable consumer sentiment and corporate business conditions despite the ongoing tightening stance.

Jerome Powell, Chairman of the U.S. Federal Reserve (Fed), is holding a press conference in Washington DC on the 1st (local time) after the conclusion of the Federal Open Market Committee (FOMC) meeting. [Image source=Yonhap News]

Deputy Director Park also evaluated the domestic foreign exchange market situation as favorable.

He explained, "We were able to confirm through last year's experience that our foreign exchange sector's ability to withstand exchange rate volatility has greatly improved compared to the past," adding, "Since 2014, South Korea has transitioned to a net external asset country with external financial assets exceeding financial liabilities, and currently, net external financial assets amount to about 46% of GDP, which has weakened the negative impact of a strong US dollar compared to before."

He continued, "Recently, the domestic US dollar supply and demand situation is judged to have improved compared to last year," analyzing, "Last year's significant depreciation of the Korean won relative to other countries was largely influenced by foreign exchange supply-demand imbalances caused by residents' continued overseas investment and a reduction in the current account surplus, but (now) stabilization measures such as foreign exchange swaps between the foreign exchange authorities and the National Pension Service have been put in place, and the trade balance, which had been in deficit for 15 consecutive months, has turned to a surplus trend since June this year."

Accordingly, Deputy Director Park predicted that even if the US dollar continues its strong trend for the time being due to the robust US economic situation and expectations of prolonged Fed monetary tightening, the volatility of the won-dollar exchange rate will remain low.

However, Deputy Director Park emphasized, "If global high interest rates persist for a long time, there is a possibility that risks may emerge in unexpected vulnerable sectors, spreading shocks," and "We must also pay attention to the considerable uncertainty inherent in geopolitical risks escalating due to armed conflicts in the Middle East."

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