The South Korean won is currently on a downward spiral against the US dollar, a trend that has persisted and intensified, leading to a significant new low not seen since March 2009. This depreciation has been driven primarily by the dual forces of the Federal Reserve's hawkish stance on interest rates and a rising tide of political uncertainty within South KoreaJust last Thursday, the exchange rate plummeted beyond the crucial threshold of 1450 won per dollar, marking its lowest point since the global financial crisis.

Insiders have revealed that if the average closing rate for the won remains above approximately 1450 for five consecutive trading days, it would trigger a mechanism forcing South Korean pension funds to initiate hedge strategiesThis would result in the sale of nearly $50 billion in foreign exchange to mitigate ongoing lossesSuch a drastic measure underscores the seriousness of the situation and the potential for cascading effects on the country's financial stability.

In light of these developments, both the National Pension Service of South Korea and the Bank of Korea have announced the extension and expansion of their foreign exchange swap agreements

Finance Minister Choi Sang-mok noted that additional measures would be put in place if market volatility escalates furtherThis follows a period of market turmoil where recent political unrest in South Korea has caused significant market fluctuations, pushing the won to its lowest exchange rate against the dollar in two years.

Even though South Korea's sovereign credit rating remains unchanged for the moment, warnings are surfacing from various international credit rating agencies regarding the potential for increased economic downturn should the political crisis extendThe sentiment in the market has been affected severely; traders have reduced the outlook for interest rate cuts expected from the US Federal Reserve in the coming year, which has had a ripple effect across global financial markets.

This week, Federal Reserve policy announcements contributed to a stronger dollar, with Chairman Jerome Powell indicating that any future interest rate cuts would depend heavily on the progress made in reducing inflation

His comments not only added upward pressure to the dollar but also exacerbated the downward movement of the won, fueling concerns among investorsOn Friday alone, the dollar index soared to a peak of 108.53, a level unseen since November 2022, illustrating the increasing strength of the US dollar against a backdrop of political and economic uncertainty for countries like South Korea.

Since December, the won has depreciated by 3.9% against the dollar, making it the third consecutive month of lossesYear-to-date, the currency has declined by 11%, putting it on track for its worst annual performance since 2008. This turbulent exchange rate situation is also reflected in the South Korean stock market, where major stocks such as Samsung Electronics and SK Hynix have seen significant declinesForeign investors have been pulling out, with sell-offs in the market totaling approximately 428.93 billion won.

The bond market has not remained unscathed either; the yields on three-year Korean government bonds have risen, signaling growing concerns about future interest rate projections

In this environment, market strategist Ronald Temple noted, “While US interest rate expectations are on the rise, most other major central banks, including the European Central Bank, are seeing declines in their rate expectationsThis divergence creates a strong dollar, which thrives on widening interest rate differentials that favor the US, suggesting the dollar may continue to strengthen.”

Consequently, the South Korean government has responded to the mounting challenges posed by the stronger dollar and local political instability by announcing plans to relax foreign exchange controls designed to enhance liquidity within the forex marketThis move is a direct response to the rapid depreciation of the won and aims to ease the prevailing tensions in the foreign exchange environmentAccording to a joint statement from the Ministry of Finance and the Bank of Korea, the strict regulations in place have hindered the efficiency of forex management, prompting a reassessment in light of recent events that have worsened liquidity conditions.

In practical terms, the financial authorities intend to raise the maximum limit on foreign exchange futures contracts for domestic banks and foreign banks operating in Seoul from currently imposed caps of 50% and 250% to new thresholds of 75% and 375%. Additionally, a new policy allows enterprises utilizing foreign currency loans for investments in facilities such as equipment, real estate, or land to convert these loans into won currency

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The Finance Ministry has stated that these adjustments will be implemented immediately, with a review planned to assess their efficacy and consider further expansions.

As the won continues its perilous descent, it appears akin to a runaway train lacking brakesThe forces driving this situation consist of the Federal Reserve's hawkish posture, which acts like a powerful magnet drawing investment away from the won, and the increasingly pervasive shadow of political uncertainty within South Korea that has eroded investor confidenceIn response to this turbulent scenario, South Korean financial authorities are taking swift action, rolling out measures aimed at alleviating liquidity pressures in the foreign exchange marketThese efforts serve as an injection of stability into a market beset by volatility, demonstrating a commitment to countering the daunting challenges posed by erratic exchange rate movements and striving to maintain order within the financial ecosystem of the nation.