How will KRW/USD exchange rate look like?

 

The KRW/USD exchange rate is on a hot run recently. I have written an article in June 2018 that Korean won (KRW) will depreciate against US dollar (USD), resulting in surge in KRW/USD exchange rate. The original article can be found here.

 

At that time, the exchange rate stood at about 1,075 Korean won per US dollar in June 2018. Right now, the exchange rate stands at 1,200 as of June 27 2020.

KRW/USD exchange rate since 2015

Source: Capital IQ

 

The exchange rate recently surged mainly because global uncertainty caused by COVID-19 forced investors to flock to safe assets, and sell their assets to have USD cash for liquidity. Obviously, USD is much more safe currency than KRW.

 

Although my prediction for the direction of KRW/USD exchange rate was right, my justification was more based on the difference in economic fundamentals of the two countries, US and South Korea. Namely,

  1. Rising inflation rate in South Korea will erode the value of KRW
  2. Slowing Korean economy relative to US economy

 

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How will KRW/USD exchange rate move from now? My hypothesis is that there is a further room for KRW/USD to run more caused by further depreciation of KRW relative to depreciation of USD.

 

USD will surely lose some of its value because of unlimited quantitative easing implemented by the Federal Reserve. Then, why is it likely that KRW will depreciate more than USD will depreciate?

 

  1. Korean stock market KOSPI and KRW/USD exchange rate showed inverse movements
  • This is because when foreign investors sell stocks in South Korea (KOSPI goes down), they convert Korean won to USD when they leave (KRW/USD exchange rate goes up)
  • Correlation between KOSPI and KRW/USD exchange rate from May 2015 to May 2020 shows negative 76%. Inverse relationship between two variables exists – when one variable decreases by 1%, the other increases by 0.76% and vice versa
  • But right now, even when KOSPI recovered from its low in mid-March, KRW/USD exchange rate is not going down but rather going up gradually

KRW/USD exchange rate and KOSPI index

Source: Capital IQ

  • This is an evidence that assets in South Korea, including stocks and real estate, are appreciating value not because their inherent value is going up, but because KRW is losing its currency value

 

2. Feud over Hong Kong between China and US will weaken Chinese Yuan

  • Chinese Yuan and Korean won shows close correlation. I will talk about this in a subsequent article
  • Weakening Chinese Yuan as a result of conflict between US and China will further put pressure on KRW to depreciate

 

3. Exports for South Korea has declined consistently in the last three years

  • My previous article showed that even in 2018, Korean exports showed signs of risk as semiconductor export was slowing down
  • Korean export peaked in 2017 with Samsung Electronics and SK Hynix contributing to more than 25% of exports via semiconductor exports
  • The trend has reversed, however, with South Korea recording trade deficit for the first time in April 2020 since the 2010s
  • The chart below shows the trends in exports value and trade balance (trade balance = exports value – import value)
  • If Korean companies cannot export goods to earn USD overseas, then supply of USD will decrease in foreign exchange market, leading to appreciation of USD

South Korea trade balance and export value since 2010

Source: Korea Customs Service

 

4. Bank of Korea has initiated quantitative easing and Korean government gave several millions won as stimulus check for Koreans

  • While the magnitude and size of quantitative easing and stimulus check are far larger in US than in South Korea, the key difference is that USD is an international reserve currency while Korean won is not
  • Therefore, the excess supply of USD can be absorbed by other countries that need to keep USD in their reserve
  • In contrast, excess supply of KRW can only be consumed within South Korea, domestically
  • However, with economic downturn in South Korea, the excess supply of KRW has nowhere to go
  • Increased KRW currency will cause imbalance in demand and supply, and lead to depreciation

 

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5. Rich people in South Korea are dumping Korean won and hoarding USD

  • Macroeconomic environment is getting worse in South Korea as Korean economy is slowing down and export is decreasing
  • Political environment has turned negative for rich people, as leftist political party in South Korea, Democratic Party of Korea, has garnered more than majority seats in Parliament (180 out of 300). With high inheritance tax and other tax burdens, many have already left or are preparing for immigration

 

6. North Korea

  • Geopolitical tension has elevated as South Korea government’s efforts in bringing peace resulted in vain
  • With pro-North Korea and anti-Japan President Moon Jae In and incumbent Democratic Party of Korea in power, tension will not easily subside
  • The exchange rate has always moved upward whenever risk in South Korea elevated.
  • North Korea will remain as belligerent as it has bene and will cause spikes in KRW/USD exchange rate.

 

Exchange rate is driven by a myriad of macroeconomic, political and financial factors. Predicting short term movements can thus be extremely difficult. In the long run, however, exchange rate will follow the economic fundamentals between the two countries.

 

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