USD/KRW close to multi-year highs despite rising South Korean inflation

USD/KRW analysis

USD/KRW is having a poor year, having risen to its highest level since 2009 last month in a rally largely driven by USDOLLAR strength. The Middle East conflict sparked risk-off inflows but also pushed inflation higher and nudged the Fed in a more hawkish direction. New Chair Warsh pledged to restore price stability at the mid-June hold and the upgraded median rate projection hints at one rate increase this year. ^[1]

At the same time, the won is depreciating due to rising capital outflows. Outbound foreign direct investment surged 36.2% y/y in the first quarter, largely driven by investments in overseas portfolios and capital redirected toward the US ^[2]. Meanwhile, foreign investors have been net sellers of South Korean equities this year, offloading roughly KRW 47 trillion of listed stocks in May alone ^[3]. This trend is primarily driven by mechanical portfolio rebalancing following the Kospi's rally to all-time highs, but the index's recent sharp pullbacks could exacerbate outflows.

USD/KRW benefits from these dynamics, making a strong start to July after last month's 2.6% advance. Thanks to these structural drivers, the pair is well positioned to set new highs and push toward the 2009 peak. However, there is scope for declines that would challenge the EMA200 and the bullish bias.

Despite lingering uncertainty around a lasting US-Iran deal, traffic through the Strait of Hormuz has picked up following the MoU. This has sent oil prices lower, which can ease inflationary fears and pressure on the Fed for rate increases. Chair Warsh alluded to cooling risk at the ECB Forum on Wednesday, saying that "inflation risks have come down" recently, striking a more dovish tone even though he reiterated his commitment to restoring price stability. ^[4]

Meanwhile, the Bank of Korea is moving toward a pivot and a rate hike could be delivered as early as this month. The upgraded dot plot from the last meeting shows a median rate of 3% over the next six months, leaving room for two rate increases ^[5]. Officials are grappling with mounting price pressures and today's CPI update reinforces the case for monetary tightening, with inflation accelerating to 3.2% y/y in June, the fastest pace in over two years.

Rising inflation, surging home prices and persistent won weakness provide solid foundations for tightening, and policymakers need not worry much about the impact on the economy, which is performing well thanks to the AI boom. South Korea's exports surged 70.9% y/y in June, driven by a near-tripling in semiconductor shipments. ^[6]

A strong economy, trade surpluses and shifting policy dynamics are positives for the won, and South Korean authorities are trying to support the currency ^[7], with 1,550 emerging as a level that could prompt intervention.