Investing.com -- Analysts at Capital Economics have expressed doubts about the sustainability of the Korean won's recent rally. Despite the currency's approximately 1.4% gain against the US dollar this year, they anticipate that the upward trend will reverse.
The Korean won has shown resilience in the face of a generally strong US dollar, even slightly declining against it today. The currency's performance has been notable, especially considering the shift in relative yields that have not favored the won.
The political turmoil in South Korea has been a concern for investors, but the country's political institutions have withstood the challenges, and fears of widespread industrial unrest have not come to pass. This stability is reflected in the 5.0% year-to-date rise of the KOSPI, South Korea's primary stock market index.
However, the won has experienced a significant drop since the beginning of the fourth quarter of 2024 and ranks as the poorest performer among emerging market currencies since the brief imposition of martial law in early December. While a resolution to the political crisis could potentially lead to a further rally, Capital Economics remains skeptical.
The analysts argue that the won's weakness in the previous year was largely due to a substantial shift in yield gaps, influenced by weak macroeconomic data and unexpected monetary policy actions, such as the rate cut in late November followed by dovish guidance from the central bank.
They predict that the Bank of Korea will continue to cut interest rates more aggressively than investors currently expect, to bolster economic growth and keep inflation low, which would likely result in yield gaps moving further against the won.
Additionally, Capital Economics forecasts that a weaker Chinese renminbi, anticipated in response to severe tariffs from the US, will exert downward pressure on the Korean won. Historically, the renminbi's movements have had spillover effects on other Asian currencies, including the won.
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