Daily Economics, Business & Finance Study

October 23, 2026 (KST) · Day 32
Today’s Topic: Why Exchange Rates Move — Connecting Interest-Rate Differentials, Growth, Trade Balances, Capital Flows, and Risk Appetite

1. Review of the Previous Lesson

Day 31 explained that an exchange rate is the relative price of two currencies, that a rise in USD/KRW means a stronger dollar and a weaker won, and that a company’s transaction, translation, and economic exposures must be separated. Today, we examine why the supply of and demand for currencies changes that relative price.

2. Today’s Core Concept

An exchange rate is jointly determined by current supply and demand for two currencies and the expected relative returns on assets denominated in those currencies. Analysis should consider the following six factors together.

1. Expected interest-rate differentials
2. Relative growth and inflation
3. Trade and current-account balances
4. Capital flows, including portfolio investment, direct investment, and hedging
5. Risk appetite and market liquidity
6. Expectations already priced in and newly arriving shocks

Today’s objective is to explain the conditional direction each factor can impart to USD/KRW, separate time horizons, and connect the analysis to corporate earnings and investment decisions.

3. Concept Explanation

3-1. Exchange-Rate Changes Reflect the Relative Supply and Demand for Dollars and Won

USD/KRW is the won price of one U.S. dollar. All else equal, it faces upward pressure when demand to buy dollars rises or the supply of dollars offered to the market falls.

\[ Rise\ in\ USD/KRW \Longleftrightarrow Higher\ dollar\ demand\ or\ lower\ dollar\ supply \]

Conversely, more dollar supply or less dollar demand creates downward pressure. Foreign-exchange supply and demand include not only payments for goods but also bond and equity investment, foreign direct investment, derivative hedging, debt repayment, and central-bank transactions.

3-2. The Expected Rate Path and FX Expectations Matter More Than the Current Rate Alone

All else equal, if Korea’s expected return rises relative to that of the United States, demand for won assets may increase, creating won appreciation and downward pressure on USD/KRW . If the expected U.S. rate path rises instead, dollar assets may become relatively more attractive, creating upward pressure on USD/KRW .

A simple comparison of current policy rates is insufficient.

• Markets respond more to the future rate path and unexpected changes than to rates already known.
• An international investor’s actual return depends on expected currency changes, hedging costs, taxes, and credit risk as well as interest rates.
• If a high rate compensates investors for high inflation or country risk, the currency may still weaken.

Bank of Korea lecture on exchange rates explains that rates, the current account, prices, expectations, geopolitical risk, and risk appetite jointly affect exchange rates. Federal Reserve research also shows that exchange rates can be sensitive to changes in monetary-policy expectations and interest-rate differentials.

3-3. Growth Operates in Two Directions: Capital Inflows and Higher Imports

An improvement in relative growth prospects can expand profits and investment opportunities, attract foreign capital, and raise expectations of monetary tightening. Those are currency-strengthening forces. Strong domestic demand can also increase imports and demand for foreign currency, creating a currency-weakening force.

Therefore, do not equate faster growth with a stronger currency. Identify whether growth moves capital returns, rate expectations, or imports most strongly.

3-4. Trade and Current Accounts Create Structural Foreign-Currency Flows

When an exporter converts dollar receipts into won, it supplies dollars; when an importer pays in dollars, it demands dollars. A persistent current-account surplus can support the won, but it does not move the exchange rate one-for-one on the same day for several reasons.

• Contract, shipment, and settlement dates differ.
• A company may retain foreign currency or hedge before settlement.
• Services, primary income, dividends, and interest payments also matter.
• Larger portfolio and outward-investment flows may dominate trade settlements.

3-5. Capital Flows and Positioning Can Outweigh Trade in the Short Run

Foreign purchases of Korean stocks and bonds may require won and support the currency. Korean purchases of overseas assets may require dollars and weaken the won. The actual direction depends on whether investors hedge currency risk, rebalance after valuation changes, bring in new money, or realize profits.

Separate the following when analyzing capital movements.

• Flow: money newly entering or leaving during a period
• Stock: assets held at a point in time
• Valuation effect: changes in the stock caused by equity prices, bond prices, or exchange rates
• Hedging flow: forward or swap trades that may move opposite to the underlying asset

3-6. Demand for Dollar Liquidity Can Rise in a Risk-Off Episode

When market stress rises, investors may reduce leverage and prefer deep, liquid dollar assets. The dollar can therefore strengthen even while U.S. interest rates are falling. BIS research shows that dollar strength can be closely linked to flows into emerging-market local-currency assets.

The reactions of so-called safe-haven currencies such as the dollar, yen, and Swiss franc still depend on the source of the shock, existing positions, and policy responses. Do not memorize one fixed FX direction for every risk-off episode.

3-7. Exchange Rates React to the Gap Between Outcomes and Expectations

A currency can weaken after a good economic release if the result was less favorable than the market expected. A rate hike can generate a small or opposite reaction if it was already fully priced in. Compare the reported figure with the expectation embedded in prices.

\[ New\ information =Actual\ release-Market-implied\ expectation \]

Markets are often more sensitive to a change in the path ahead than to the current level.

3-8. Priorities Differ by Analytical Horizon

The idea can be summarized as follows.

\[ Exchange-rate\ change=f(Expected\ rate\ differential,\ relative\ growth\ and\ inflation,\ current\ account,\ capital\ flows,\ risk\ appetite,\ expectations) \]

This expression is a checklist, not an exact linear forecasting equation. The magnitude and even the sign of each coefficient can change with the period and shock.

4. Simple Numerical Example

All figures below are hypothetical learning examples, not actual market data or forecasts. Taxes, transaction costs, and credit risk are ignored.

① Currency Expectations That an Interest-Rate Differential Misses

Assume the expected one-year return is 3.5% on a Korean asset and 5.0% on a U.S. asset. If the exchange rate is unchanged, the U.S. asset yields 1.5 percentage points more.

If the investor expects the won to appreciate by 2.0% against the dollar over one year, however, the Korean asset’s simplified expected dollar return is approximately:

\[ 3.5\%+2.0\%=5.5\% \]

That is 0.5 percentage points more than the U.S. asset’s 5.0%. Actual analysis must incorporate compounding, forward prices, and hedging costs, but the example shows why the interest-rate differential alone cannot determine the investment direction.

② A Simplified Example of One Month’s Dollar Flows

\[ Net\ dollar\ demand=1.8+0.7+0.4-1.5=1.4\ billion\ dollars \]

The simplified total implies excess demand for dollars and upward pressure on USD/KRW . Now assume that risk aversion and an upward revision to the U.S. rate path accompany those flows and the exchange rate rises from 1,400 to 1,470.

\[ USD/KRW\ percentage\ change =\frac{1{,}470}{1{,}400}-1 =5.00\% \]

\[ Change\ in\ the\ dollar\ value\ of\ the\ won =\frac{1{,}400}{1{,}470}-1 =-4.76\% \]

This does not mean $1.4 billion of net dollar demand mechanically caused a 5% rise. Market depth, existing positions, hedging, policy responses, and order timing can make the same net demand produce different price changes.

5. Practical Use in Equity and Company Analysis

① Start With a Six-Cell FX Dashboard

② Use Three Scenarios Instead of a Point Forecast

• Stronger-won scenario: a lower expected U.S. rate path, better Korean growth, a current-account surplus, and foreign inflows
• Base scenario: offsetting rate and flow factors keep the currency in a range
• Weaker-won scenario: a higher expected U.S. rate path, risk aversion, greater overseas investment, and foreign-currency debt repayment

For each scenario, recalculate the company’s foreign-currency revenue, costs, interest, hedges, and taxes. Exporters, importers, companies with foreign-currency debt, and owners of foreign subsidiaries have different sensitivities.

③ Separate the Level From the Surprise

A wide rate differential may have little incremental FX effect if it is not expected to widen further. A small differential can still accompany a large currency move after a policy surprise. A useful investment log records the actual release, consensus expectation, prior reading, immediate exchange-rate response together.

④ FX Changes Earnings and Valuation at the Same Time

A weaker won can raise the won translation of dollar revenue while also increasing import costs, foreign-currency interest, and inflation. If inflation and interest rates lift the discount rate, valuation multiples may fall even if earnings estimates rise.

\[ FX\ shock \rightarrow Revenue,\ costs,\ interest,\ and\ hedge\ results \rightarrow FCF \]

\[ FX\ shock \rightarrow Inflation,\ policy\ rates,\ and\ risk\ premiums \rightarrow Discount\ rate\ and\ valuation \]

⑤ Check for Changes in the Correlation Regime

Foreign equity buying and won appreciation may coincide in one period, but hedging or rebalancing can weaken that relationship in another. Do not treat a historical correlation as a permanent causal law. Reassess the dominant driver and transacting investors in the current regime.

⑥ Avoid Common Misconceptions

• A wider Korea–U.S. interest-rate differential guarantees a rise in USD/KRW is false.
• A current-account surplus does not guarantee same-day won appreciation.
• Foreign investors’ equity purchases can differ from their actual won purchases because of hedging.
• Selecting one plausible cause only after the exchange rate moves is merely an ex post explanation.
• Estimating a range of earnings and cash-flow sensitivities is more practical than claiming certainty about direction.

6. What to Find in Filings

Korean Companies: DART

DART.

Prioritize consolidated financial statements and separate average and period-end rates, as well as net exposure before and after derivatives.

U.S. Companies: 10-K and 10-Q

SEC EDGAR.

• 10-K Item 1 Business: geographic operations, production locations, invoicing currencies, and supply chains
• 10-K Item 1A Risk Factors: exchange rates, capital controls, geopolitics, and repatriation risk
• 10-K Item 7 / 10-Q Part I, Item 2 MD&A: reported and constant-currency growth, FX effects, and outlook
• 10-K Item 7A / 10-Q Part I, Item 3: foreign-exchange market-risk sensitivity and hedging policy
• Item 8 / 10-Q Part I, Item 1 notes: foreign currency, derivatives, segments, debt, and accumulated other comprehensive income

A company’s disclosed sensitivity may be a static calculation based on a specific date and assumption. Keep it separate from economic exposure that includes long-term changes in competitive prices and demand.

Market and Macro Data Outside Filings

Diagnosing exchange-rate drivers requires data outside company filings.

• Bank of Korea ECOS: policy rates, market rates, the balance of payments, and exchange-rate time series
• Bank of Korea Financial and Economic Snapshot: major rates and won–dollar market indicators
• Federal Reserve FRED: U.S. rate, inflation, and exchange-rate series
• BIS exchange-rate statistics: bilateral, nominal effective, and real effective exchange rates
• Korea Exchange and Korea Securities Depository data: foreign securities flows and investor-type trading

Align frequency and period, and distinguish stocks from flows, nominal from real, release dates from reference periods, spot FX from hedging transactions. Also label filing facts, independently calculated results, and forecasts separately.

7. Key Takeaways

• Exchange rates are jointly determined by current currency supply and demand and expected relative returns.
• Interest-rate differentials must be analyzed with expected paths, surprises, currency expectations, and hedging costs—not just current levels.
• Better growth can attract capital or raise imports, so its currency direction is not automatic.
• The current account creates structural FX flows but does not move exchange rates one-for-one because of settlement lags and capital movements.
• Portfolio flows, rebalancing, hedging, and risk appetite can outweigh trade flows in the short run.
• The gap between a result and market expectations may explain short-term FX reactions better than a good headline number.
• The variables that matter most differ across intraday, multi-month, and multi-year horizons.
• In company analysis, estimate scenario sensitivities in revenue, costs, debt, hedges, and discount rates instead of asserting one certain currency direction.

8. Three Check Questions

Question 1

The expected U.S. rate path is revised higher while the expected Korean rate path is unchanged. All else equal, what pressure does this create on USD/KRW? Include at least one caveat.

Question 2

The expected one-year return is 3.2% on a Korean asset and 4.8% on a U.S. asset. If an investor expects the won to appreciate by 2.0% against the dollar over one year, what is the Korean asset’s simplified expected dollar return, and how does it compare with the U.S. asset? Ignore taxes, transaction costs, and credit risk.

Question 3

Assume one month brings $2.0 billion of converted export proceeds, $2.3 billion of import payments, $0.4 billion of foreign purchases and conversions into Korean securities, and $0.5 billion of overseas-asset purchases by Korean investors. Calculate simplified net dollar demand and the direction of pressure on USD/KRW .

Answers and Explanations

Answer 1

The relative expected return on U.S. assets rises and may increase dollar demand, creating upward pressure on USD/KRW . The actual direction and magnitude depend on whether the rate path was already priced in and on changes in risk appetite, the current account, capital flows, and hedging costs.

Answer 2

\[ Expected\ dollar\ return\ on\ Korean\ asset \approx3.2\%+2.0\%=5.2\% \]

\[ 5.2\%-4.8\%=0.4\%p \]

The Korean asset is 0.4 percentage points higher under this simplified approximation. Actual returns depend on currency-forecast errors, compounding, hedging costs, and credit risk, so the result is not guaranteed.

Answer 3

Dollar demand is $2.8 billion: $2.3 billion for imports plus $0.5 billion for overseas assets. Dollar supply is $2.4 billion: $2.0 billion from exports plus $0.4 billion from foreign securities investment.

\[ Net\ dollar\ demand=2.8-2.4=0.4\ billion\ dollars \]

All else equal, this creates upward pressure on USD/KRW . The $0.4 billion net demand alone cannot determine the actual percentage increase.

Next Lesson — Day 33:
“Nominal and Real Exchange Rates — Reading Competitiveness Through Prices, Purchasing Power Parity, and Effective Exchange Rates”