"Dollars Are Abundant, Yet the Exchange Rate Keeps Soaring"?Should You Invest by Understanding the Structure? [Practical Finance]

All Players Bet on Exchange Rate Rise, Prefer Lending Dollars Over Selling
Spot FX Market Faces Demand Imbalance Despite Lower Funding Market Rates
Focus on Whether Expectations of "Further Increases" Will Subside When Making Investment Decisions

The won-dollar exchange rate has been soaring for several days, surpassing the 1,470-won mark. The only day it fell this year was when U.S. Treasury Secretary Scott Bessent recently pointed out that the decline in the value of the Korean won "does not align with Korea's strong economic fundamentals."

Although there is said to be an abundance of dollars in the foreign currency funding market, why is the exchange rate still rising, and how high could it go? As an investor, how should one interpret the gap between the appropriate exchange rate predicted by Secretary Bessent and major global investment banks, and the current rate? Most importantly, what should be the focus when forecasting future exchange rate levels to make investment decisions? Let’s examine the recent exchange rate situation from a structural perspective.

On the 19th, domestic and foreign nationals were inquiring about currency exchange at a bank exchange counter at Incheon Airport. Photo by Yonhap News.

"Dollars Are Abundant in the Foreign Currency Market"-So Why Is the Exchange Rate Rising?

On January 15, Bank of Korea Governor Rhee Changyong emphasized during a press briefing following the decision to hold interest rates steady, "Recently, people say the exchange rate is rising and it’s hard to find dollars, but it is actually very easy to obtain dollars in Korea right now." This is because, although dollars are available, market participants expect the exchange rate to rise, so they are reluctant to sell dollars in the spot foreign exchange market and instead prefer to lend them in the funding market (foreign currency funding market) even at lower interest rates.

In this context, the Bank of Korea recently highlighted on its blog that the additional premium on dollar funds during foreign exchange swaps (exchanging won for dollars) has significantly decreased. For three-month contracts, the premium dropped from 41 basis points (bp; 1bp=0.01 percentage points) at the end of June 2025 to 22bp at the end of December 2025, and further to 4bp as of January 15. This indicates that it has become easier for financial institutions such as banks to borrow dollar funds from each other, demonstrating the abundance of dollars. This is partly because exporters are selling less of their foreign currency earnings than before and are instead holding them as foreign currency deposits. During November and December last year, whenever the exchange rate dropped, small and medium-sized importers in particular increased their foreign currency deposits.

The "Flexible Adjustment Plan for Foreign Exchange Soundness Regulations" announced by the Bank of Korea and the government to encourage foreign currency inflows into Korea is also contributing to increased foreign currency liquidity in the funding market. Additionally, last year, foreign investment in Korean bonds more than doubled (2.7 times) compared to the previous year, and since more than half of this bond investment is funded by borrowing dollars through foreign exchange swaps and investing the resulting won, it has become a major source of foreign currency supply.

Not Selling, Only Lending-Spot Market Sees Intensified Dollar Demand

In contrast, in the spot foreign exchange market, strong demand for dollar purchases has persisted, maintaining the high exchange rate. In the long term, exchange rates are influenced by fundamental factors such as inflation differentials, economic growth rates, and interest rate gaps between countries. However, in the short term, imbalances in supply and demand determine the direction and magnitude of exchange rate movements. Looking at last year’s foreign exchange supply and demand, the current account surplus from January to November 2025 was a substantial 101.8 billion dollars. However, during the same period, residents’ overseas securities investment and direct investment amounted to 129.4 billion dollars and 26.8 billion dollars, respectively, far exceeding foreign investment in domestic securities (50.4 billion dollars) and direct investment (6.3 billion dollars). While the size of the current account surplus (foreign exchange supply) was similar to the net total of securities and direct investment (99.5 billion dollars), suggesting a neutral effect on the exchange rate, in reality, there was a significant mismatch in supply and demand in the spot market.

This is because the proportion of dollar sales by exporters has decreased compared to the past, while the supply of funds to the foreign currency funding market through foreign currency deposits by financial institutions has increased. About 80% of residents’ overseas securities investments are in stocks, meaning most are converted to dollars and flow out of the country, whereas only about half of foreign investors’ securities investments are in bonds that are converted to won, resulting in limited dollar sales in the spot market. This imbalance in the dollar trading market was especially pronounced in the fourth quarter of last year. Residents’ overseas stock investments recorded an unprecedented outflow of around 30 billion dollars in October and November 2025. Meanwhile, a significant portion of foreign investors’ bond investment funds were supplied as dollar funds through swap transactions, leading to abundant liquidity in the foreign currency funding market. This month, individual overseas securities investments are continuing at a pace similar to that of last October and November.

An employee is organizing US dollars at the Hana Bank Counterfeit Response Center in Jung-gu, Seoul. Photo by Yonhap News Agency

Focus on Whether Expectations of "Further Increases" Will Subside When Making Investment Decisions

The average won-dollar exchange rate forecast by seven major global investment banks for the end of the first quarter of this year is 1,441 won, and for the end of the year, 1,411 won-converging in the low 1,400-won range. Domestic institutions also expect the exchange rate to remain in the low to mid-1,400-won range this year, with the prevailing view that the current rate is excessive compared to economic fundamentals.

Ultimately, the key to stabilizing the exchange rate is easing expectations of a weaker won. Kwon Amin, a researcher at NH Investment & Securities, said, "Looking at the first half of this year, the strong performance of the KOSPI, led by semiconductors, is expected to continue, and in the bond market, there is momentum for capital inflows due to the inclusion in the World Government Bond Index (WGBI). Since December last year, the National Pension Service has started currency hedging, which is a different environment from the fourth quarter of last year. There is a possibility of relative supply-demand improvement. If the authorities’ willingness to intervene is confirmed near the previous high (1,480 won), the likelihood of breaking through that level is low." However, he added, "For a more meaningful decline in the won-dollar exchange rate, net external assets must decrease significantly in terms of supply and demand. Considering structural changes, it will be difficult for the lower bound to drop much further."

To ease expectations, foreign exchange authorities must improve fundamental factors in the medium to long term, while reducing supply-demand imbalances in the short term. Yoon Kyungsoo, Director General of the International Department at the Bank of Korea, emphasized, "It is necessary to implement consistent policies to stabilize expectations that have formed over several months. The National Pension Service’s new framework leaves room for adjustments in currency hedging and overseas investment strategies, which could help improve foreign exchange supply and demand." He added, "The planned inclusion in the WGBI in April this year and improved accessibility to the domestic capital market will bring about substantial improvements in supply and demand."