By Park Chong-hoon
I am often asked how the U.S. dollar-Korean won exchange rate will move in the near term, especially by acquaintances who have to send money to the U.S. for their kids. They are worried about the recent rapid pace of the won's depreciation and are feeling the pain of having to spend 10 to 15 percent more in Korean won terms to send their kids to school in the U.S. Corporates, especially importers, are facing similar pressure. Their profits can fluctuate by over 10 percent depending on the time of buying and selling dollars.
Nonetheless, the pain of a weak won will be felt by everyone, especially at a time of rising inflation. A weak currency can push up inflation further, reducing purchasing power. If you are considering traveling overseas to celebrate the lifting of pandemic restrictions, you will quickly find that it is very costly.
What do we need to do? Buy dollars now, or wait for the dollar to weaken ― and is that likely to happen this year? Should we sell dollars now, or wait for it to strengthen further?
First, it is difficult to predict how the forex market will move. Many academic economists tried to forecast forex markets using various econometric models. They have found that no econometric model outperforms the "random walk" model that says tomorrow's price will be the same as today's price. The economic factors that affect the forex market ― such as interest rates, capital flows and economic growth ― are already priced in today. They do not explain current forex volatility or levels, underscoring the difficulty of forecasting the forex market.
We know that the dollar is strong this year for a few reasons. The Fed has started hiking interest rates and is expected to raise them further. The market expects the Fed to hike its base rate further by 2.5 percent in 2022, much faster than the Bank of Japan and the European Central Bank.
Rising U.S. rates attract capital flows to the U.S., supporting the strong dollar. Global instability is also supporting the dollar. Because of the Ukraine war, investors are looking for a safe-haven currency ― and the dollar is playing that role. Because of unfavorable rate differentials, the Japanese yen and Swiss franc are weak and have lost their safe-haven currency status.
The question is, how much more will the dollar strengthen because of these factors? The dollar has already appreciated c. 8.2 percent year-to-date in 2022. Some market participants are now wondering whether it has gone too far. As the 10-year U.S. Treasury yield reaches the c. 3 percent level, some think the Fed's monetary policy is fully priced into the forex market.
Some argue that the dollar has appreciated too fast and will go down from here. The U.S. economy is strong now but is expected to slow down in the second half with higher interest rates. The Fed may need to worry about growth towards the end of the year, so it will not be able to hike interest rates as much as it plans to, despite inflation concerns. If so, some market participants say that the dollar will start to weaken fast.
Others argue that dollar strength is not over yet, as uncertainty around the Ukraine war is likely to continue. The situation may worsen from here as Russia takes more aggressive action to win the war. Tighter economic sanctions against Russia could hurt the EU-area economy and bring higher inflation. Proponents of further dollar strength also argue that China's economic slowdown due to COVID-19 lockdowns is not yet fully priced in.
Both arguments make sense, and the dollar could move either way from here. We think the best way to navigate this uncertain environment is to reduce risk ― hedge against forex market volatility and plan the timing of dollar buying or selling, rather than waiting until the last minute with one direction in mind. While we think the dollar will eventually depreciate from the current historically high level, we do not know that this will happen within the next couple of months. If your time horizon is shorter than this, you may need to think about buying dollars.
We know from experience that it is unwise for corporates to try to profit from a volatile forex market. Corporates should make money from their products and business plans, not by betting on the forex market. We believe hedging can help firms minimize risks associated with extreme forex volatility. However, this is only effective if the right hedging strategy is implemented at the right moment.
Park Chong-hoon (ChongHoon.Park@sc.com) currently heads the Korea Research Team at Standard Chartered Korea. Before joining the bank, he worked as a senior research fellow and head of telecommunication policy at the Korea Information Society Development Institute (KISDI).
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Nonetheless, the pain of a weak won will be felt by everyone, especially at a time of rising inflation. A weak currency can push up inflation further, reducing purchasing power. If you are considering traveling overseas to celebrate the lifting of pandemic restrictions, you will quickly find that it is very costly.
What do we need to do? Buy dollars now, or wait for the dollar to weaken ― and is that likely to happen this year? Should we sell dollars now, or wait for it to strengthen further?
First, it is difficult to predict how the forex market will move. Many academic economists tried to forecast forex markets using various econometric models. They have found that no econometric model outperforms the "random walk" model that says tomorrow's price will be the same as today's price. The economic factors that affect the forex market ― such as interest rates, capital flows and economic growth ― are already priced in today. They do not explain current forex volatility or levels, underscoring the difficulty of forecasting the forex market.
We know that the dollar is strong this year for a few reasons. The Fed has started hiking interest rates and is expected to raise them further. The market expects the Fed to hike its base rate further by 2.5 percent in 2022, much faster than the Bank of Japan and the European Central Bank.
Rising U.S. rates attract capital flows to the U.S., supporting the strong dollar. Global instability is also supporting the dollar. Because of the Ukraine war, investors are looking for a safe-haven currency ― and the dollar is playing that role. Because of unfavorable rate differentials, the Japanese yen and Swiss franc are weak and have lost their safe-haven currency status.
The question is, how much more will the dollar strengthen because of these factors? The dollar has already appreciated c. 8.2 percent year-to-date in 2022. Some market participants are now wondering whether it has gone too far. As the 10-year U.S. Treasury yield reaches the c. 3 percent level, some think the Fed's monetary policy is fully priced into the forex market.
Some argue that the dollar has appreciated too fast and will go down from here. The U.S. economy is strong now but is expected to slow down in the second half with higher interest rates. The Fed may need to worry about growth towards the end of the year, so it will not be able to hike interest rates as much as it plans to, despite inflation concerns. If so, some market participants say that the dollar will start to weaken fast.
Others argue that dollar strength is not over yet, as uncertainty around the Ukraine war is likely to continue. The situation may worsen from here as Russia takes more aggressive action to win the war. Tighter economic sanctions against Russia could hurt the EU-area economy and bring higher inflation. Proponents of further dollar strength also argue that China's economic slowdown due to COVID-19 lockdowns is not yet fully priced in.
Both arguments make sense, and the dollar could move either way from here. We think the best way to navigate this uncertain environment is to reduce risk ― hedge against forex market volatility and plan the timing of dollar buying or selling, rather than waiting until the last minute with one direction in mind. While we think the dollar will eventually depreciate from the current historically high level, we do not know that this will happen within the next couple of months. If your time horizon is shorter than this, you may need to think about buying dollars.
We know from experience that it is unwise for corporates to try to profit from a volatile forex market. Corporates should make money from their products and business plans, not by betting on the forex market. We believe hedging can help firms minimize risks associated with extreme forex volatility. However, this is only effective if the right hedging strategy is implemented at the right moment.
Park Chong-hoon (ChongHoon.Park@sc.com) currently heads the Korea Research Team at Standard Chartered Korea. Before joining the bank, he worked as a senior research fellow and head of telecommunication policy at the Korea Information Society Development Institute (KISDI).
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