Exchange rate and bonds: won–dollar exchange rate expected to stabilize if U.S. cuts rates

The won–dollar exchange rate, which started last week in the 1,460-won range, closed at 1,473.30 won in overnight trading on the 5th. The same day, the People’s Bank of China devalued the yuan's central parity rate by 0.02% to 7.0749 yuan per dollar, which is interpreted as having been reflected in the market. The won usually moves in a similar direction to the yuan because South Korea has a high dependence on the Chinese economy.

Next week's exchange rate is expected to be determined by the U.S. central bank (Fed)'s policy rate decision. Market experts expect the Fed to cut the policy rate by 0.25% percentage points at the Federal Open Market Committee (FOMC) meeting on the 9th–10th. If the rate cut materializes, the U.S. policy rate would fall to an annual 3.5~3.75%, narrowing the interest rate gap with South Korea (annual 2.5%) to a maximum of 1.25% percentage points. Many analyses say that a narrower rate gap would lead to an improvement in domestic foreign exchange supply and demand and contribute to exchange rate stability.

Jin-kyung Lee, a senior researcher at Shinhan Investment Corp., said, "If the United States begins cutting rates, the exchange rate in the high-1,400-won range could fall slightly," but she also forecasted, "Given that domestic dollar demand remains strong and U.S. employment and inflation data are forthcoming, a large decline is unlikely."

The domestic bond market was range-bound. On the 5th in the Seoul bond market, the yield on 3-year government bonds closed at an annual 2.994%, up 0.003% percentage points from the previous week (annual 2.991%). The 3-year government bond yield also closed at an annual 3.045% on the 1st, rising to this year's highest level.

Experts expect government bond yields to hover around an annual 3% for the time being. Chan-hee Kim, a researcher at Shinhan Investment Corp., said, "An increase in government bond issuance due to expansionary fiscal policy will act as a burden on bond market supply and demand," and predicted, "For the time being, the 3-year government bond yield will move in the range of annual 2.95~3.10%."

Ik-hwan Kim lovepen@hankyung.com