The won-dollar exchange rate has continued to rise day after day, but some in the market say it is time to prepare for a sharp reversal to a stronger won. Despite an abundance of dollars in the foreign currency funding market, an abnormal gap persists as the foreign exchange market continues to face a dollar shortage, and analysts say a steep drop in the exchange rate (undershooting) could occur the moment expectations for further gains break.

The KOSPI closes at 7,475.94, up 184.03 points (2.52%) from the previous session, as the index is displayed in the dealing room of Hana Bank in Jung-gu, Seoul, on the 10th in the afternoon. As of 3:30 p.m., the won–dollar exchange rate falls 4.7 won to 1,501.4, and the KOSDAQ closes at 837.43, up 43.43 points (5.47%). /Courtesy of Yonhap News

Moon Da-un, a researcher at Korea Investment & Securities Co., said in a report on the 13th, "The gap between the foreign currency funding market and the foreign exchange market is likely to eventually close," adding, "Just as rising jeonse prices in the real estate market eventually push up sale prices, the adjustment now is likely to be toward a recovery in the won's value."

Moon said the foreign currency funding market and the foreign exchange market are currently moving in different directions.

In the foreign currency funding market, the expense of procuring dollars has fallen to historically low levels and the dollar premium has turned negative, but in the foreign exchange market, a worsening dollar shortage is pushing up the won-dollar exchange rate.

Moon said, "In the foreign currency funding market, dollars are not that scarce, while in the foreign exchange market, a dollar shortage is sending the exchange rate surging."

As the backdrop for this, Moon pointed to a "self-fulfilling trend" in which expectations of a higher exchange rate lead to an actual rise.

Corporations and investors, anticipating a higher exchange rate, are delaying dollar sales and bringing forward purchases, which is sustaining the actual rise in the rate.

Moon said, "The expectation that the exchange rate will rise is bringing forward dollar buying and delaying dollar selling, which is in turn pushing the rate higher," adding, "The problem is that if expectations flip to a decline, all positions could move the other way and the rate could fall sharply."

Moon assessed that factors that could temper expectations for a higher exchange rate have been gradually emerging.

Notably, Hanwha Ocean recently expanded its hedging by selling $2 billion in forward contracts, and SK hynix is expected to boost dollar supply as it plans to use about 40 trillion won raised through an ADR listing for domestic investment.

Moon also cited the prospect of increased dollar inflows from strong semiconductor exports, demand for currency exchange for August interim corporate tax prepayments, and potential foreign capital inflows from inclusion in the World Government Bond Index (WGBI) as stabilizing factors for the exchange rate.

Moon cautioned, however, "It is difficult to predict when and what event will break expectations for a higher exchange rate," while adding, "As the government's measures to balance foreign exchange supply and demand and major corporations' dollar supply gather steam, a turning point in exchange rate expectations is increasingly likely."

Moon added, "The narrowing of the gap between the foreign currency funding market and the foreign exchange market could proceed gradually, but it could also occur abruptly due to an unexpected trigger," and said, "How far the exchange rate falls in the second half of this year will be an important variable in determining the appropriate level for next year and the year after."

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