South Korea’s ‘Black Friday’ in Financial Markets – A Perfect Storm Driven by Global Risk Aversion

As I reviewed the flood of news that hit the market this morning, it truly felt like ‘Black Friday’ was not an exaggeration. Seeing the KOSPI drop nearly 4% and the won-dollar exchange rate soar to the 1,475 won range reminded me of the market panic during the 2008 financial crisis or the early days of the COVID-19 pandemic in 2020. However, this situation is showing a slightly different pattern.

The most notable aspect is that this phenomenon is driven by the spread of risk aversion due to concerns over global stock market overvaluation. Particularly, as the U.S. Nasdaq continues to hit record highs, the valuation burden has increased, leading investors to collectively seek safe assets. With the current PER of the S&P 500 exceeding 26 times, significantly above the historical average of 16 times, such an adjustment was somewhat anticipated.

In the case of the South Korean market, more complex factors are at play. The KOSPI has fallen significantly below the 2,400 level, down about 8% for the year. This starkly contrasts with the 22% rise in the U.S. S&P 500 over the same period. The net selling by foreign investors has accumulated to over 15 trillion won this year, reflecting a significant decline in global investors’ interest in the South Korean market.

Personally, I found the remarks by Bank of Japan Governor Kazuo Ueda particularly intriguing. His statement in the National Assembly about continuing interest rate hikes based on inflation expectations led to a reversal in the yen/dollar exchange rate, which had a larger-than-expected impact on the South Korean market. As the yen strengthens, the competitive dynamics among Asian currencies are shifting.

The Accompanying Decline in the Cryptocurrency Market and Its Implications

The drop in Bitcoin’s price to 12,791,000 won is also noteworthy. This figure, down 1.54% from the previous day, is said to be the lowest since April 21. Considering the global Bitcoin price plummeted from the $90,000 range to the $85,000 range, the decline in the South Korean market could be seen as relatively limited.

More importantly, the correlation between cryptocurrencies and traditional financial markets is rising again. In the past, Bitcoin was claimed to serve as a ‘digital gold’ or a safe asset, but in recent years, with a correlation coefficient with Nasdaq hovering around 0.7, it is effectively classified as a risk asset. The influx of institutional investors has further accentuated the synchronization with traditional assets.

Trading volume on the domestic virtual asset exchange Upbit reportedly increased by more than 30% compared to usual, indicating simultaneous panic selling and bottom-fishing attempts by individual investors. The narrowing of the kimchi premium to around 2% also seems to reflect the pressure of overseas capital outflows.

Interestingly, the decline in Ethereum and other altcoins was greater than that of Bitcoin. In the case of Ethereum, it fell 3.2% from the previous day, showing that the ‘flight to quality’ phenomenon, where investors flock to relatively safer Bitcoin during risk aversion situations, is also occurring within the cryptocurrency market.

The Structural Causes of the Exchange Rate Surge and Future Outlook

The surge in the won-dollar exchange rate to the 1,475 won range was truly shocking. Starting from the high 1,200 won range earlier this year, the won has weakened by nearly 20% to date. This should be seen as the result of complex structural factors rather than just a one-day phenomenon.

The biggest factor is undoubtedly the interest rate differential between South Korea and the U.S. While the U.S. Federal Reserve maintains its benchmark interest rate at 5.25-5.50%, the Bank of Korea remains at 3.50%, resulting in an interest rate gap of about 175 basis points. In such a scenario, the outflow of dollar funds from South Korea is a natural occurrence.

The more fundamental issue is the weakening growth momentum of the South Korean economy. The GDP growth rate for the third quarter of this year was only 1.5% year-on-year, falling significantly short of the government’s target of 2.6%. Particularly, the manufacturing PMI remains in contraction territory at 48.3, and exports, excluding semiconductors, continue to be sluggish.

The Bank of Japan’s indication of interest rate hikes is also a burden for South Korea. As the yen strengthens, the competitiveness of South Korean products in exports to Japan could weaken. This is especially true for key industries like automobiles, steel, and chemicals, which have many competing products with Japan, making them highly susceptible to exchange rate fluctuations.

The Bank of Korea faces a real dilemma. To stabilize the exchange rate, it needs to raise interest rates, but doing so could further dampen the already struggling domestic economy. With household debt exceeding 1,900 trillion won, raising interest rates is burdensome, yet it is also difficult to ignore the surge in the exchange rate.

The possibility of intervention by foreign exchange authorities is increasing. It is worth noting whether a resistance line will form in the mid-1,400 won range. Historically, when the rate exceeded 1,450 won, authorities often intervened actively. However, despite foreign exchange reserves being sufficient at around $420 billion, there are limits to continuous intervention.

In the coming weeks, the market is likely to react more sensitively to U.S. economic indicators and statements by Federal Reserve officials. Particularly, the U.S. November PMI and consumer confidence index, to be released next week, are expected to be crucial variables in determining the market’s direction. If the U.S. economy turns out to be stronger than expected, the dollar’s strength is likely to persist further.

Personally, I believe this adjustment is likely a short-term phenomenon. Although there are structural factors, the fundamentals of the South Korean economy have not significantly deteriorated. However, with volatility expected to continue for the time being, it seems to be a time for investors to pay more attention to risk management. Especially if there are overseas investment positions without currency hedging, it may be worth reevaluating them.

This article was written after reading the article ‘Black Friday’…KOSPI Drops Nearly 4% and Exchange Rate Hits 1,475 Won and adding personal opinions and analysis.

Disclaimer: This blog is not a news outlet, and the content reflects the author’s personal views. The responsibility for investment decisions lies with the investor, and no liability is assumed for investment losses based on this article’s content.