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--U.S. Diplomatic And Financial Mkt Developments Could Trigger Weakness
By Stuart Allsopp
     SINGAPORE (MNI) - The extremely low level of volatility in USDKRW provides
another warning signal for the won, which already faces headwinds from widening
U.S.-Korea real rate differentials. As we have seen in the past, periods of low
volatility tend to give way to USDKRW spikes. Optimism surrounding the Trump-Kim
summit appears to be fully priced into the pair.
     Volatility in the Korean won has been extremely low over recent months in
spite of the heavy news flow around U.S.-North Korea relations, rising risks of
a U.S.-China trade war, widening U.S.-South Korean interest rate differentials,
and the recent EM FX selloff. USDKRW has now gone 68 days without a 1% move and
90 days without the pair moving 2% or more from its 50DMA. Implied volatility is
also low historically.
     Such low levels of volatility have been seen before and they tend to give
way to periods of heightened volatility, usually spelling trouble for the won.
Of course, volatility could stay low for longer and it does not tend to be a
great timing signal, but the high level of complacency adds another element of
risk to the won, which is already facing headwinds from the ongoing rise in U.S.
real interest rates.
     The spread between the yield on U.S. 2-year bonds and Korean 2-year swaps
is 48bps, having moved 60bps in the US's favour since the start of the year.
This has occurred even as long-term inflation expectation differentials between
the two countries have remained unchanged. It appears as though declining CDS
spreads in Korea, which tend to move closely in line with USDKRW implied
volatility, have been the major contributor to the won's resilience, suggesting
it is worth looking at what factors could trigger a re-widening of risk spreads.
     The main risks lie outside of the control of South Korean policymakers and
largely depend on diplomatic and financial market developments in the U.S. There
is a risk that high expectations for a diplomatic breakthrough between
Washington and North Korea, any lack of progress at the upcoming meeting could
shift investors' focus back towards global trade concerns. G7 talks over the
weekend failed to resolve the U.S.'s differences with other major trading
partners while U.S.-China trade tensions remain far from resolved. Given South
Korea's high degree of trade openness (with exports amounting to roughly 45% of
GDP and net exports being a major contributor to real GDP growth), any
disruptions in global trade would be detrimental to the Korean economy.
     Another risk comes from a re-emergence of global credit constraints
stemming from widening U.S. high-yield bond yields. It was US credit stresses
that triggered the blowout in Korean risk spreads back in 2008 and while Korea's
external debt picture is much more solid now than it was then, the same cannot
be said for the U.S., which has seen debt levels surge once again and the
quality of loan issuance deteriorate, particularly at the lower end of the
     Any renewed tightness in US credit markets could again catch investors off
guard and trigger a rise in default risk among even the more stable emerging
markets such as Korea.
     --NO 2008 REPEAT
     That said, notwithstanding the above risks, a repeat of the 2008 sell-off
in the won is something that MNI sees as highly remote given that the currency
is much less overvalued than it was then and the country's external debt levels
have improved markedly. There is also a much lower probability of U.S. real
yields undergoing a super spike as they did in 2008 amid the collapse in
inflation expectations given the US's loose fiscal policy and the lessons the
Fed learnt during the last crisis.
--MNI Singapore Bureau; +65 8233 2326; email:
--MNI London Bureau; tel: +44 203-586-2225; email:
[TOPICS: M$A$$$,M$U$$$,MI$$$$]