[Why&Next] Exchange Rate Enters 1200 Won Range... Numerous Factors Behind Dollar Weakness

H2 Outlook: End of US Interest Rate Hikes Expected

As the won-dollar exchange rate attempts to enter the 1,200-won range, analysis suggests that the dollar's strong trend is entering its final phase. Expectations for price stability have increased ahead of the U.S. Consumer Price Index (CPI) announcement, and with the possibility of the U.S. interest rate hikes ending in the second half of this year, the dollar is expected to weaken in the medium to long term.

According to the Seoul foreign exchange market on the 12th, the won-dollar exchange rate was 1,292.6 won at 9:10 a.m., down 1.1 won from the previous trading day. The exchange rate opened at 1,292.0 won, down 1.7 won from the previous day, showing limited movement.

With the Financial Monetary Committee meeting to decide the base rate scheduled for the 13th, the won-dollar exchange rate has recently shown a downward trend. The exchange rate, which at one point during the previous day’s session dropped to 1,290.4 won, widened its decline and closed at 1,293.7 won, down 12.8 won, marking the lowest closing level since the 21st of last month.

The decline in the exchange rate is attributed to revived risk asset preference ahead of the U.S. June CPI announcement on the 12th (local time), as inflation is expected to slow. The June CPI is forecasted to rise 3.1% year-on-year, down from 9.1% in June last year. If the CPI slowdown is confirmed, expectations may grow that the U.S. Federal Reserve's monetary tightening stance could weaken.

Seunghyuk Kim, a researcher at NH Futures, evaluated, "Ahead of the U.S. CPI announcement, the decline in the Mannheim used car price index is temporarily raising expectations for price stability," adding, "Not only the non-farm payroll data but also the employment trend index is increasing the possibility of cooling in the labor market, contributing to the weak dollar trend."

"Expectations for Price Stability... Dollar Weakness in the Medium to Long Term"

Experts predict that the dollar's strong trend, which has lasted about two years since the fourth quarter of last year, is gradually coming to an end, and the won-dollar exchange rate will show a downward stabilization trend. Changseop Oh, a researcher at Hyundai Motor Securities, said, "As risk asset preference has revived recently, the won-dollar exchange rate is making another attempt to enter the 1,200-won range," adding, "With the possibility of the U.S. interest rate hikes ending in the third quarter of this year becoming prominent, the dollar is expected to weaken in the medium to long term."

Globally, growing expectations for economic recovery and foreign investors' net buying of domestic stocks from a foreign exchange supply and demand perspective are also cited as factors strengthening the won. While South Korea's trade balance recorded its peak deficit in January this year, it showed signs of improvement by posting a surplus last month for the first time in 16 months. From an investment fund perspective, the continued net investment in domestic bonds by foreign investors and sustained net buying of domestic stocks since the second half of last year are interpreted as positive signals.

In particular, as global supply chain uncertainties ease and inflation slows, the global monetary tightening phase is entering its final stage, which is expected to drive the dollar's weakness. Researcher Oh said, "Since December last year, the G20 Organization for Economic Cooperation and Development (OECD) leading economic index has turned to a rebound, raising expectations for global economic recovery," adding, "Assuming global economic recovery, given South Korea's high external dependence, the won is likely to strengthen from a foreign exchange supply and demand perspective."

U.S. Additional Rate Hike Variable... Record High Korea-U.S. Interest Rate Gap

[Image source=Yonhap News]

However, the possibility of foreign exchange market volatility due to additional U.S. interest rate hikes is expected to be the biggest variable affecting the won-dollar exchange rate's direction. While the Bank of Korea's Financial Monetary Committee is widely expected to keep the base rate unchanged on the 13th, the U.S. Federal Reserve (Fed) is anticipated to raise the policy rate by 0.25 percentage points on the 25th (local time).

If the Fed raises rates by 0.25 percentage points this month, the Korea-U.S. interest rate gap could widen to a record 2.00 percentage points, potentially burdening the foreign exchange market. From the perspective of the won, which is not a key currency, if the base rate is significantly lower than that of the U.S., foreign investment funds may flow out in pursuit of higher yields. Yoonmin Baek, a researcher at Kyobo Securities, said, "Regarding the Korea-U.S. interest rate gap, if foreign exchange market volatility does not fundamentally expand, the possibility of policy responses due to the widening gap will be limited," adding, "However, if the gap widens beyond 2.00 percentage points, concerns about policy responses such as rate hikes may increase."

Many also believe there is no need for excessive concern as the interest rate gap between Korea and the U.S. has already widened to a record 1.75 percentage points, yet the exchange rate remains stable. Foreign capital inflows and outflows are determined not only by interest rate differentials but also by the attractiveness of each country's assets. Jina Kim, a researcher at Eugene Investment & Securities, explained, "There is a lack of empirical evidence that funds consistently flowed out when the Korea-U.S. base rate gap widened in the past, and the Bank of Korea also emphasizes this point." Yonggu Cho, a researcher at Shin Young Securities, added, "Compared to last year, the won's depreciation pressure has significantly eased, and with the trade balance turning to surplus and semiconductor market recovery expected in the second half, there seems to be no need for the Bank of Korea to raise rates further due to the exchange rate."