Korea–U.S. market interest rate gap narrows to 0.5 percentage points...What about the impact on the exchange rate?

[Financial News] Korea–U.S. market interest rates are converging at similar levels in the 3% range, rapidly narrowing the rate gap between the two countries. As the spread in market rates has shrunk significantly compared with the Korea–U.S. policy rate differential, attention is turning to how this will affect future monetary policy and the exchange rate.
According to the Bank of Korea (BOK) Economic Statistics System on the 20th, the yield on the 3-year Korea Treasury Bond stood at an annualized 3.08% the previous day, 0.573 percentage points (p) lower than the 3-year U.S. Treasury note (3.653%). This is roughly one-third of the Korea–U.S. policy rate differential, which is 1.25 percentage points at the upper bound.
The Korea–U.S. 3-year yield spread narrowed to the 0.4 percentage point range last month, marking its lowest level in two years and seven months since May 2023. Although expectations for a U.S. policy rate cut have receded somewhat this month, the gap is still holding in the 0.5–0.6 percentage point range.
The inversion of market interest rates has persisted since 2022. The spread, which had widened to as much as 1.9 percentage points early last year, has since been on a narrowing trend, and in particular shrank rapidly from the 1.6 percentage point range in June to the 0.4 percentage point range in December. This is seen as being influenced by the BOK’s decision to keep its policy rate unchanged for five consecutive meetings since last July, maintaining a hawkish stance.
The fact that the market rate gap is smaller than the policy rate differential reflects that expectations about future monetary policy have already been priced into interest rates. While the BOK recently removed the phrase “rate cut” from its monetary policy statement, hinting at a possible end to the easing cycle, expectations for additional rate cuts by the Federal Reserve (the Fed) remain intact. The Bank of Korea New York Representative Office reported that investment banks expect the Fed to cut rates by an additional 0.25–0.75 percentage points, with the easing cycle likely to conclude in the second or third quarter.
Attention is also focusing on how the narrowing rate gap will affect the exchange rate. In general, it could act as a factor pushing down the US Dollar–South Korean Won exchange rate, but some analysts note that the correlation is limited, given that the exchange rate surged in the second half of last year despite the narrowing rate differential. Yongo Kwon, head of the International Finance Research Team, Bank of Korea, said, “It is difficult to explain the recent sharp rise in the exchange rate solely by the Korea–U.S. interest rate differential,” pointing instead to imbalances in foreign exchange supply and demand caused by residents’ increased overseas securities investment as a key factor.
imne@fnnews.com Hong Ye-ji Reporter