The Won is Back
2025.5.13
Three-line summary
The Korean won has recently strengthened due to optimism over easing US-China tensions and broader Asian currency gains.
Investors are hedging more with the won, which serves as a proxy for less liquid Asian currencies like the Taiwan dollar.
However, the Bank of Korea warns of continued exchange rate volatility due to Korea’s thin forex market and global uncertainties.
What’s going on?
The Korean won has recently strengthened against the US dollar, influenced by a general rise in Asian currencies due to anticipated easing of US-China tensions, according to market analysts on Wednesday. The won began trading at 1,380 per dollar, a significant 25.3 won increase from the prior day. This notable appreciation occurs six months after the won nearly reached 1,500 against the dollar following former President Yoon Suk Yeol's martial law declaration on December 3.
Why?
Most Asian currencies are gaining value, with the Taiwan dollar experiencing a significant surge of nearly 10%, alongside strength in the Chinese yuan and Japanese yen. The Taiwan dollar's rapid appreciation over two sessions is its largest gain in 30 years and has increased hedging demand for the South Korean won, which acts as a proxy currency.
A proxy hedge allows countries with currencies that are relatively illiquid to reduce risk by hedging with a correlated currency that has more liquidity.
The won serves as a proxy for the Taiwanese currency due to the similar export-oriented nature of their economies and key industries like chipmaking and electronics. Asian currencies are becoming attractive as their previous undervaluation is now seen as an advantage for traders looking to profit from the weakening premium of the US dollar.
Investors have traditionally held onto US Treasury bills and bonds, but as the US dollar weakens, they’re cutting their losses. Taiwan insurance companies sold their unhedged investments in US Treasuries in response. Previously, there was no reason to hedge a US investment. Now, investors recognize the need to hedge their currency exposure and diversify their investments.
Hedging is an investment strategy employed to mitigate financial risk. It involves holding an asset that is expected to perform inversely to a core investment. The purpose of a hedge is to counterbalance potential losses in the core investment by gains in the hedging asset, thereby limiting overall financial exposure.
Bloomberg data indicates that currencies such as the South Korean won, Indonesian rupiah, and Indian rupee are among the most undervalued in emerging markets compared to their historical averages. These currencies have been fundamentally cheap for an extended period. While a slight correction has begun, they remain relatively inexpensive, and investors had previously underinvested in Asia.
Goldman Sachs and Barclays suggest that the Korean won, which significantly declined last month due to Trump's tariffs, is well-positioned for further appreciation. Overall sentiment towards undervalued Asian currencies has improved as concerns about Trump's policies diminish the dollar's appeal, and increasing optimism for trade deals enhances the attractiveness of emerging market assets. The South Korean won reached a six-month high driven by optimism surrounding US trade negotiations potentially leading to reduced tariffs.
Will this trend continue?
Bank of Korea Governor Rhee Chang-yong stated that it is premature to determine the longevity of the won's appreciation. He also noted uncertainty regarding the U.S.'s preference for a strong or weak dollar.
Rhee predicted continued and unpredictable exchange rate volatility due to the "thin" nature of Korea's foreign exchange market, characterized by low trading volume. He contrasted this with the US Treasury market, which, despite its own volatility, maintains market function due to its substantial trading volume.
The limited number of participants in Korea's market exacerbates short-term currency fluctuations, which will intensify if market participants perceive a lack of concern from the BOK regarding currency movements.
While many anticipate some appreciation in Asian currencies, the sustainability of these gains beyond initial catch-up movements is questionable. It is unlikely that the current global growth environment will necessarily lead to significant outperformance of Asian currencies.