South Korea and the United States agreed not to manipulate exchange rates for competitive gains and stated that macroprudential or capital flow measures will not target these rates. Both countries will share foreign exchange intervention activities monthly and concur that intervention is reserved for excessive volatility, addressing both depreciation and appreciation.
The joint statement between South Korea and the US did not reference a bilateral currency swap or South Korea’s pension fund. Following the agreement, the South Korean Won experienced a decline, with USD/KRW increasing from 1,402.50 to 1,409.45, marking a 0.20% rise on the day.
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The new foreign exchange agreement signals that South Korean authorities will be less likely to intervene to strengthen the won. This means we should expect higher volatility in the USD/KRW pair over the coming weeks. Traders should prepare for wider daily price swings than we have seen recently.
This changed environment makes buying options volatility an attractive strategy. Implied volatility for one-month USD/KRW options has already jumped to 9.5%, a level not sustained since the global inflation scare we saw back in 2023. This suggests the market is already beginning to price in a period of greater uncertainty.
Market Reaction And Strategic Moves
The market’s immediate reaction, pushing the USD/KRW rate towards 1,410, suggests a clear upward bias for the pair. We should therefore consider establishing long positions in USD/KRW, perhaps using call options to limit potential downside risk. This move is a test of levels we haven’t seriously challenged since the turbulence of late 2022.
This policy is a major shift from what we have grown accustomed to. For instance, looking back, the Bank of Korea sold a net $5.9 billion in foreign reserves in the second quarter of 2024 alone to support the won. Under this new agreement, that level of intervention is far less probable unless market conditions become extremely chaotic.
We must also view this in the context of South Korea’s recent economic data, which showed exports to China fell 4% year-over-year last month. A gradually weaker won may provide a necessary boost to the country’s export sector. This gives authorities another reason to tolerate the currency’s current depreciation.
The absence of a bilateral currency swap agreement is a critical detail, removing a powerful stabilization tool that was used during the financial crises of 2008 and 2020. Without this safety net, any sudden global risk-off event could lead to a much sharper depreciation in the won than seen in the past. This makes holding protective positions against a sharp drop in the won more important.
