Exchange Rate Plummets, Interest Rate Hikes Continue… Will Uncertainty Be Resolved?

A recent forecast suggests that the sharp decline in the won-dollar exchange rate could negatively impact the sales and profits of export companies. Concerns are raised that a roughly 15% drop in the exchange rate could reduce profits recognized in won and weaken price competitiveness. Export companies have previously secured price competitiveness and increased sales profits thanks to a weaker won.

An unusual trend has continued since last year, where the won-dollar exchange rate remained strong despite the dollar showing weakness. This phenomenon originated from large corporations like Samsung Electronics and Hynix making large-scale investments in the U.S. and paying in dollars for raw material settlements, such as crude oil and gas, leading to a large physical outflow of foreign currency. Furthermore, South Korea's foreign exchange crisis trauma and selling by foreign investors contributed to the won's weakness.

South Korea's current account balance recorded an all-time high in monetary terms last year. This indicator represents the net profit earned from overseas by buying and selling goods and services. Last year, the current account surplus as a percentage of GDP reached 6.6%, and it is estimated to record an annual current account surplus of around 18% this year. This current account surplus is considered an important indicator of the South Korean economy's external soundness.

The appropriate won-dollar exchange rate, calculated using a formula where it moves similarly to the dollar, was found to be approximately 1,290 won. It is anticipated that if the current exchange rate approaches 1,290 won, the speed of further exchange rate decline will gradually slow down. This suggests that the exchange rate may be moving past a period of rapid fluctuation and entering a stabilization phase. An analysis also indicated that there is still room for the won-dollar exchange rate to fall by about 50 won more than its current level.

The Bank of Korea has projected that South Korea's per capita Gross National Income (GNI) could reach $40,000 this year. South Korea's per capita GNI recorded $30,000 in 2014. If it achieves $40,000 this year, it would represent a 30% growth in approximately 12 years.

Recently, the Korean won exchange rate has shown a temporary synchronization phenomenon with other Asian currencies such as the Japanese yen and Chinese yuan. However, this synchronization is analyzed as a short-term phenomenon based on the dollar exchange rate ratio rather than actual economic closeness. South Korea's current account surplus as a percentage of GDP is about 20%, while Japan has not earned much foreign currency recently.

Just a month or two ago, expectations for interest rate cuts were prevalent in the U.S. bond market. However, recently, views on interest rate hikes have rapidly spread across Wall Street. This drastic shift in interest rate forecasts has led to rising Treasury yields, acting as a key factor holding back the stock market. Such volatility in the bond market is increasing investor anxiety.

Traditionally, falling oil prices tend to drive down interest rates. However, a divergence phenomenon has recently appeared in the bond market where interest rates either rise or remain high despite falling oil prices. This allows for an analysis that the bond market is reflecting not only oil prices or future expectations but also various uncertainties such as fiscal issues to a greater extent. Investors are concerned that other factors, like fiscal problems, are at play in a situation where interest rates are maintained despite falling oil prices.

The 'Taylor Rule,' a formula for calculating the appropriate U.S. interest rate, is once again drawing attention. Currently, the interest rate level calculated by this Taylor Rule is aligning with the 10-year Treasury yield. In the past, the market had a strong tendency to predict the Fed's monetary policy, but now it is thoroughly reacting to currently announced economic indicators (data) rather than future predictions. While the Consumer Price Index (CPI) shows a downward trend, the Fed appears to be using the Taylor Rule as one of its benchmarks to find a reference point by integrating various indicators.

There were instances where the appropriate benchmark interest rate changed from 4.5% to 5%. This was because the appropriate interest rate was adjusted based on changes in economic data. The Fed's judgment on the benchmark interest rate changed, reflecting various economic environmental changes, including inflation.

Analysis reveals why the Fed cannot stop raising interest rates even though the Consumer Price Index (CPI) fell below expectations. The inflation that the Fed and the bond market are watching continues to rise, with Personal Consumption Expenditures (PCE) and core inflation particularly increasing across the board. This rise in core inflation is taken as a signal that overall inflationary pressures persist, even if consumer prices temporarily decline. Even within the Fed, there are differences of opinion on interest rate hikes, and for several months, it was uncertain whether interest rates could stabilize even if betting on rate hike probabilities decreased.

Stock market movements during interest rate hike periods have varied based on past cases. During the interest rate hike period of 2022, stock prices tended to fall as rates were raised. In contrast, when the U.S. raised interest rates in the mid-2010s, stock prices initially moved sideways, but after two or three rate hikes, stocks actually rose. This shows that investors perceive the market differently based on past experience, rather than vague fear.

The pace and method of the Fed's interest rate hikes have had a significant impact on the market. The 2015 rate hike created tension in the market through ample warnings but proceeded with a slow pace. In contrast, in 2022, the start of rate hikes was late, followed by rapid giant steps that quickly raised rates. This difference increased market uncertainty and acted as the most unfavorable factor. Abrupt policy changes without warning reduce market predictability and dampen investor sentiment.

It was suggested that carrying out an interest rate hike in September and delivering a strong message would be more favorable to the market than prolonging uncertainty until the end of the year. This emphasizes the need for proactive measures to avoid a situation where a small issue escalates into a major problem. An analysis suggests that an early conclusion to the interest rate hike cycle would be positive, as prolonged uncertainty could make the market more unstable.