[Issue Interview] "No Recurrence of King Dollar This Year... US Rate Cut Expected Only Next Year"

Yang Seok-jun, Director of Foreign Exchange Operations at Bank of Korea
"Limited Capital Outflow Despite Widening Domestic and Foreign Interest Rate Gap"

"The king dollar and god dollar situation from last year will not be repeated. With improvements in conditions in Europe and China, and a better outlook for emerging markets, a temporary reversal in the won-dollar exchange rate is inevitable, but the dollar's dominance is expected to be limited."

Yang Seok-jun, Director of Foreign Exchange Operations at the Bank of Korea, made this assessment regarding the recent rise in the won-dollar exchange rate during an interview with Asia Economy held on the 24th of last month at the Bank of Korea's Sogong Annex in Seoul. The exchange rate, which surged last month amid renewed fears of tightening by the U.S. Federal Reserve (Fed), has recently calmed somewhat as the yuan strengthened due to expectations of an economic recovery in China. However, hawkish remarks from senior Fed officials concerned about inflation continue to keep the strong dollar sentiment alive. Director Yang stated, "The sense of crisis over Europe's energy supply has improved, and the European Central Bank (ECB) is following a tightening path as stringent as the Fed's. If policies outside the U.S. also align, there is a limit to the dollar strengthening alone, so from a broader perspective, the dollar's strength has eased."

Yang Seok-jun, Director of Foreign Exchange Operations at the Bank of Korea, is being interviewed on the 24th at the Bank of Korea Sogong Annex in Jung-gu, Seoul. Photo by Kang Jin-hyung aymsdream@

There is considerable concern about the exchange rate in the recent foreign exchange market. Last month, the Monetary Policy Committee kept Korea's base interest rate steady at 3.5% per annum. As expectations for the U.S. terminal interest rate rose, some cautiously forecast that the interest rate gap between Korea and the U.S. could widen to as much as 2 percentage points. Considering that the historical maximum interest rate gap between Korea and the U.S. was 1.5 percentage points, if the gap widens beyond this, there are growing concerns that foreign capital could exit and the exchange rate, which had barely stabilized, could surge again. Director Yang said, "For the interest rate gap factor to significantly influence the exchange rate, there must be strong confidence in one side's market, whether the U.S. or Korea. The Bank of Korea has sufficiently left open the possibility of future rate hikes at the February Monetary Policy Committee meeting, and since our economy has potential capital inflows from China's reopening and the semiconductor market, it is not advisable to mechanically or arithmetically worry about the Korea-U.S. interest rate gap." Furthermore, Director Yang judged that the recently released solid U.S. economic indicators signal a turning point indicating that the Fed will need to make new decisions.

-The exchange rate surpassed 1,300 won for the first time in about two months amid expectations of prolonged Fed tightening. What is your outlook for the exchange rate going forward?

▲Looking at the Dollar Index (DXY), which shows the average value of the U.S. dollar against six major world currencies, it does not seem likely that the U.S. dollar will show the ultra-strong "king dollar" status again in the international financial market. Of course, some reversal of the dollar weakness that rapidly progressed after the inflation peak in November last year due to optimism about disinflation seems inevitable. However, unlike last year, uncertainty about the Fed's monetary tightening intensity or interest rate volatility is not expected to persist for a long time, and the economic situations in Europe and China have improved significantly compared to last year. While the U.S. economy remains strong, Europe no longer perceives the war or energy supply crisis as severely as before, and the ECB is following a tightening path as stringent as the Fed's. China is also emerging as a promising investment destination this year among global investors due to the reopening effect. From this perspective, at least within this year, there are limits to the U.S. dollar showing a one-directional strength.

-Last month, the Monetary Policy Committee kept rates steady, and the Korea-U.S. interest rate gap is expected to widen further. Is there concern about capital outflows?

▲For capital to outflow due to an expanding interest rate gap, a strong expectation of won depreciation must first form. For the interest rate gap to significantly affect the exchange rate going forward, there must be a supporting forecast that the U.S. will rapidly raise rates as it did last year. However, since the market already reflects a Fed rate hike path above 5%, adding new variables for further widening the interest rate gap carries high forecast risk. Also, with the Bank of Korea maintaining a tightening stance and leaving open the possibility of additional rate hikes, the impact of the interest rate gap on capital outflows is considered limited.

-With U.S. employment, inflation, and consumption indicators exceeding market expectations, fears of tightening continue. When might the Fed start cutting rates?

▲Recent U.S. economic data clearly indicate that it is premature for the Fed to loosen its tightening stance. The possibility of a policy pivot by the Fed within this year is almost gone, and the Fed itself is facing a new turning point in its economic outlook. It is uncertain whether rates will need to be raised faster or maintained longer. At the March Federal Open Market Committee (FOMC), the Fed is likely to revise upward the terminal rate from the 5.1% indicated in the December dot plot last year. Fed Chair Jerome Powell, in last month's FOMC press conference and Economic Club dialogue, stated that future policy will be data-dependent and anticipated that inflation decline will be bumpy.

-In U.S. economic forecasts, views diverge between soft landing and hard landing, while recently a no-landing scenario has emerged.

▲For now, the possibility of a hard landing this year is considered almost gone. Employment and consumption indicators have exceeded expectations, and disinflation is slowing, leading the market to raise its expectations for the Fed's terminal policy rate and push back the timing of rate cuts to next year or later. The Fed will likely raise rates a few more times and keep open the possibility of additional hikes while monitoring changes in economic indicators. If inflation does not fall as expected, the Fed may find it difficult to tolerate this.

-At the end of last year, as the king dollar weakened and global economic slowdown increased safe-haven demand, interest in central banks' gold holdings surged. The Bank of Korea stopped purchasing gold since February 2013; what are the reasons and future plans?

▲When the U.S. dollar weakened rapidly recently, gold prices rose, but considering the short-term outlook for a dollar rebound, further gold price increases are likely limited. The Bank of Korea has steadily pursued diversification of its foreign exchange reserves in terms of currencies and commodities alongside reserve growth. Besides the U.S. dollar, about 30% of the currency holdings are other currencies, with gold being part of that. In terms of commodities, besides U.S. and other major developed countries' government bonds, the Bank holds asset-backed securities, corporate bonds, and over 10% in equities. From this perspective, gold holdings should be decided comprehensively considering overall portfolio diversification and reserve growth trends, not solely based on price forecasts of a specific commodity. Moreover, gold has high price volatility and is a non-yielding asset with no interest or dividends, so currently, the necessity to hold gold is not significant.

-During last year's rapid exchange rate rise, controversy arose over the appropriate level of foreign exchange reserves. What is your evaluation of the current reserve level?

▲Whenever the exchange rate rises rapidly and foreign exchange reserves decline, the adequacy criteria suggested by the International Monetary Fund (IMF) and others are often cited, leading to recurring debates about reserve levels. Foreign exchange reserves are public foreign currency assets held by the Bank of Korea and the government, which were crucial for market stabilization when private foreign currency assets were small. However, now Korea's total net external financial assets, excluding reserves, exceed $300 billion significantly. Corporations, various pension funds, and even individuals invest in foreign currency assets from a portfolio perspective. Furthermore, under a free-floating exchange rate system, reserves can be used appropriately when needed. Although reserves decreased significantly due to market stabilization measures last year, other countries like Singapore faced similar situations. Also, as the government pursues a higher level of foreign exchange market liberalization and internationalization, invoking emerging market reserve standards and recalling foreign exchange crisis trauma is inappropriate.

Yang Seok-jun, Director of Foreign Exchange Operations at the Bank of Korea, is being interviewed on the 24th at the Bank of Korea Sogong Annex in Jung-gu, Seoul. Photo by Kang Jin-hyung aymsdream@

-With increased financial market volatility, portfolio adjustments for foreign exchange reserve management seem necessary. How do you plan to allocate assets this year?

▲Last year, the use of foreign exchange reserves was effective in stabilizing the exchange rate. Therefore, reserves should be managed to be available timely when needed. Although reserves have slightly increased recently, it will not be easy to quickly recover to previous levels. Considering the U.S. dollar's movements in international financial markets, residents' continued overseas investments, and the current account surplus, now is a time to focus more on the basic goals of reserve management?safety and liquidity?rather than diversification for higher returns.

-The Bank of Korea is entrusting foreign exchange assets to domestic native asset management firms to enhance international competitiveness. I heard you plan to increase this ratio to 10%.

▲Domestic private asset management firms have been entrusted with about $3 billion from the Bank of Korea until last year, managing stocks and bonds in international financial markets. Going forward, we plan to evaluate the firms' capabilities and, if possible, increase the number of institutions and scale. The investment scope has expanded from Chinese stocks to developed country stocks and bonds, and the management strategy has been passive so far, but we plan to diversify strategies to include active management seeking excess returns. By entrusting foreign currency assets, we aim to provide domestic managers with opportunities to build track records in foreign currency asset management and continue to serve as a catalyst to compete with foreign asset managers in international financial markets.

-ESG (Environmental, Social, Governance) has become a trend in investment. What are the concrete results of entrusted asset management applying ESG standards?

▲The Bank of Korea's Foreign Exchange Operations Department is expanding ESG investments to meet the public responsibility expected of a central bank. ESG standards are applied not only to entrusted assets but also to directly managed assets, mainly stocks and corporate bonds, and as of the end of last year, the asset size meeting these standards approaches $15 billion. We plan to expand the use of external indexes for negative screening strategies and, in the medium term, establish our own screening system and introduce ESG integration strategies across the entire asset portfolio.

-You were appointed Director of Foreign Exchange Operations in June 2020. Could you share your achievements and reflections?

▲I was appointed during the COVID-19 pandemic, so the organization had to operate in an emergency mode, which limited our core activities. However, during this time, we had good opportunities to hold video seminars with renowned economists and strategists through active non-face-to-face meetings and conferences, allowing us to organize market outlooks. Expanding entrusted assets to domestic asset managers to enhance international competitiveness was a notable achievement, as was drawing up a roadmap for ESG investment directions. The Bank of Korea's Foreign Exchange Operations Department is recognized by the World Bank and other central banks as a model for well-established foreign exchange management systems. Many developing countries visit and seek exchanges to learn from our system. We must continue efforts to develop it further.