Three major divergence phenomena in the currency depreciation of Japan and South Korea

In the first half of this year, the Japanese yen and the Korean won depreciated by 10.06% and 4.39% respectively against the US dollar, and there has been no trend from weakness to strength so far. It is estimated that it will be very difficult for both of them to regain lost ground in the second half of the year. Currency depreciation itself is not an isolated phenomenon, especially in the context of the heavy pace of global economic recovery and the changing world geopolitics, the normal logical link and traditional causal relationship of currency depreciation have been damaged and distorted, and many deviations have evolved. Among them, the corresponding concrete ecology presented by the currencies of Japan and South Korea is the most typical.

Export Trade: Not Increasing but Decreasing

Changes in the exchange rate often have a direct regulatory effect on a country’s export trade, and the depreciation of the local currency is conducive to improving and promoting exports. However, with the sharp decline in the yen and Korean won this year, the exports of the two countries have not only failed to rise at the same time, but have experienced a considerable decline, and have been affected, and the trade deficit between the two countries has also continued to expand.

The latest statistics show that on the basis of a sharp contraction of 15.2% year-on-year in May, South Korea’s export trade fell by another 6% in June, falling for nine consecutive months. At the same time, the year-on-year decline in single-month exports hit the longest historical record; Japan, since October last year, the country’s actual exports have been in a state of decline. Although the latest May data has slightly increased by 0.6% year-on-year, the growth rate is the lowest in the past two years. Dragged down by sluggish exports, South Korea had a cumulative trade deficit of US$26.2 billion in the first half of the year, while Japan had a trade deficit for 22 consecutive months as of May this year, with the deficit reaching US$370 billion in the first five months.

The downturn in exports from Japan and South Korea is firstly related to the weak recovery of the global economy. At the same time, it is also closely related to the continued tightening of the Federal Reserve’s monetary policy, which has led to the passive follow-up of many central banks in many countries around the world. In particular, driven by the continuous interest rate hikes in many economies, the costs of global corporate production and private consumption have increased significantly, and external demand directly linked to exports has been suppressed. According to the latest forecast of the International Monetary Fund, global economic growth will bottom out at 2.8% this year; while the World Trade Organization pointed out that international trade this year will only grow by 1.7% year-on-year, significantly lagging behind global GDP growth. Under the increasingly cramped external environment, even Japanese and Korean export products with a good reputation in the international market are difficult to display their strengths.

However, it is worth noting that although the central banks of the United States and Europe are the source of tightening monetary policies, the resulting changes in regional demand do not seem to have inhibited the exports of Japanese and Korean companies. Data show that as of May, the US market accounted for 18% of South Korea’s total exports. Although South Korea’s exports to the US dropped slightly in June, the overall upward trend remained unchanged. In the same month, South Korea’s exports to the EU increased for five consecutive months, with a substantial year-on-year increase of 9.2% in the first half of the year. For Japan, exports to the US in the first five months increased by 10.9% year-on-year, while exports to the EU increased by 9.5% in the same period. In contrast, the returns generated by the Asian market, which has traditionally been the main export destination for Japanese and Korean companies, have weakened significantly. Data show that in the first five months of this year, Japanese and South Korean companies’ exports to Asia have fallen by more than 1%.

Looking back, although changes in the exchange rate will affect exports, monetary factors are definitely not the only or decisive variable. Changes in trade exports are often the result of the linkage of multiple factors, especially when non-monetary factors affecting exports dominate, and the decline in exchange rate prices may have more limited support for exports. Therefore, for a country, it is impossible to pin its export hopes on the competitive devaluation of the currency.

The stock market: not down but up

Generally speaking, there is a positive relationship between the exchange rate market and the stock market. On the one hand, the decline of the local currency exchange rate means that domestic assets are not attractive to foreign capital, and the withdrawal of foreign capital will be associated with the adjustment pressure of the stock market; on the other hand, the depreciation of the local currency will directly cause the downward revaluation of the stock value, so the funds on the market will flee from danger, and the funds outside the market will not dare to enter the market rashly. Not only that, the foreign exchange market and the stock market will be affected by similar economic and political backgrounds, and the trends often show obvious characteristics in the same direction. If the exchange rate depreciates too quickly, it may amplify the adjustment of the stock market. However, since the beginning of this year, the Japanese and Korean stock markets seem to have rewritten the traditional correlation and causal logic between the foreign exchange market and the stock market. In addition to the Nikkei 225 index continuously hitting record highs in the past 33 years, South Korea’s KOSPI index also surged 14.66% in the first half of the year, and it seems to have entered a technical bull market.

The parallel development of Japanese and South Korean stock markets first reflects the common characteristics of the two countries’ economic fundamentals. In the first half of this year, South Korea’s GDP grew by 0.9%, and achieved two consecutive quarters of growth, getting rid of the risk of technical recession caused by the negative growth in the fourth quarter of 2022. On the basis of reversing the negative economic growth in the previous quarter in the fourth quarter of last year, Japan’s GDP in the first quarter increased by 0.4% month-on-month, and the annualized year-on-year quarterly growth rate also achieved two consecutive increases, which also completely blocked the risk of technical recession. Although the economic growth of Japan and South Korea does not seem to be very strong, as a positive signal, it undoubtedly directly stimulates the improvement of market risk awareness, and at the same time enhances the investment confidence and optimistic expectations of stock market participants.

Another common factor driving the rise of Japanese and Korean stock markets is the reform and innovation at the market level of the two countries. Given that Japanese companies have a preference for hoarding cash, but at the same time ignore the disadvantages of giving back to shareholders, the Tokyo Stock Exchange issued new regulations in March this year, requiring listed companies with a price-to-book ratio below 1 to disclose specific improvement measures. In South Korea, the stock market was upgraded from the MSCI emerging market country index to the developed country market index in June this year. For this reason, the South Korean government has carried out drastic reforms on the foreign exchange market, including extending foreign exchange trading hours and lowering the threshold for overseas financial institutions to participate in the foreign exchange market.

In addition to the very similar logical attribution, the rise of the Japanese and Korean stock markets also has a more obvious self-induction and driving force. The analysis found that since the beginning of the year, major technology companies and automakers have contributed to the rise of the Korea Composite Index. The former, such as Samsung Electronics and SK Hynix, and the latter, Hyundai and Kia, account for more than 80% of the South Korean KOSPI index. The reason why they are favored is that on the one hand, products such as ChatGPT and Bard have greatly promoted the global artificial intelligence industry. Investors believe that Korean chip manufacturers such as Samsung Electronics will benefit greatly from it; South Korean battery producers and manufacturers are expected to benefit greatly from the revised details of the U.S. inflation-cutting bill.

Compared with the South Korean stock market, the Japanese stock market has risen stronger this year, and the positive energy gathered behind it is also more abundant. In addition to the “stock god” Buffett’s high-profile buying of the stocks of five Japanese trading companies including Itochu Corporation and Mitsubishi, which created a “herd effect” for the Japanese stock market, the more important thing is that the Bank of Japan has been releasing the voice that it is not eager to adjust the yield curve control policy, which has strengthened the “safety cushion” for the further rise of asset prices in the secondary market; in addition, the Bank of Japan has continued to buy ETFs. It is also worth noting that even though it has risen for half a year, the price-to-book ratio of the Topix Index is currently only about 1.3 times, which is consistent with the average level of the past 10 years, showing that the stock valuation of Japanese companies still has a lot of room for improvement compared with that of the United States.

In summary, although exchange rate depreciation will negatively correlate with the stock market, if at the same time more positive factors form an effective hedge and create new upward momentum, a country’s stock market can also stage a more independent bull market. On the other hand, the exchange rate factor is only an external variable that affects the stock market. The main force that determines the rise and fall of the stock market actually comes from the quality and quality of listed companies. In contrast, many companies in Japan and South Korea have undoubtedly won good scores from the market, whether it is the improvement of management and operation efficiency, the iterative optimization of products, or the continuous improvement of profitability. Correspondingly, it has injected positive momentum into the stock market.

Monetary policy: not tight but loose

According to the half-year cycle comparison, at least in the past 10 years, the depreciation of the yen has only exceeded the depreciation of the same period of this year 5 times, and the Korean won has only 3 times. The sharp decline in the exchange rate objectively requires the central banks of Japan and South Korea to tighten monetary policies to boost the value of their currencies. Otherwise, the risk of foreign capital withdrawal and imported inflation may occur. It is also worth noting that the Fed and the European Central Bank have a high probability of continuing to raise interest rates this year. The interest rate differential between Japan and South Korea and the U.S. and European currencies has widened, and the depreciation pressure on the former will further increase.

In order to control price rises, the Bank of Korea raised the domestic benchmark interest rate by 300 basis points within a year and a half. Its pace of raising interest rates was much earlier than other major central banks in the world. However, the Bank of Korea was one of the first central banks in the world to suspend interest rate hikes. Since it stopped raising interest rates in February this year, the Bank of Korea’s four monetary policy meetings have continuously made decisions to maintain the current 3.5% interest rate level. The Bank of Japan not only continued to maintain the negative interest rate that has been implemented for seven years, but also has no intention of ending the two major water release tools of QE and QQE. Interestingly, the central banks of Japan and South Korea announced in almost the same tone that inflation will return to around the 2% policy target around the end of this year, which means that they will not consider adjusting the existing monetary policy before then.

The analysis found that the corresponding monetary policy management was not adopted under the scenario of a sharp depreciation of the exchange rate, which only shows that the governments of Japan and South Korea have encountered more difficult problems. Although both Japan and South Korea have come out of the shadow of “technical recession”, South Korea’s latest June manufacturing purchasing managers’ index (PMI) has dropped to a record low of 47.8, and it has been below the line of 50 for 12 months. In this regard, the Bank of Korea has adjusted its economic growth this year from 1.6% previously expected to 1.4%. Looking at Japan again, domestic consumption, which accounts for nearly 60% of GDP, has shrunk for two consecutive months until May. At the same time, the core consumer price index in June continued the trend of rising year-on-year for 22 months, and the counterpressure from consumption has further strengthened. In this regard, Global Data, a global data analysis company, predicts that the growth of Japanese consumer spending will slow down by 1.2 percentage points year-on-year this year, which will increase the uncertainty of Japan’s economic growth prospects. Whether to tighten monetary policy to improve the exchange rate or keep monetary policy loose to maintain economic growth, Japan and South Korea jointly chose the latter.

Jumping out of the economic category of Japan and South Korea and looking at the entire Asian economy, you will find that almost all Asian currencies have experienced considerable depreciation this year, just like the currencies of Japan and South Korea. At the same time, with the sluggishness of exports from Japan and South Korea, Vietnam’s exports fell sharply by 11.6% in the first five months of this year, Singapore’s decline expanded to 6%, Thailand’s and Cambodia’s exports fell by more than 5% and 4% respectively, and even China’s exports, which have always been strong in exports, only slightly increased by 0.3% during the same period. Under such circumstances, any country that takes the lead in tightening monetary policy will put its exports in a more embarrassing situation. Japan and South Korea’s export contribution in the first half of the year was already negative, and they are unwilling to see the situation continue to deteriorate. Therefore, they would rather choose to endure the pain of exchange rate decline than damage their export competitiveness.

Theoretically speaking, the central bank’s monetary policy regulation is mainly aimed at the four major goals of economic growth, full employment, inflation, and balance of payments. Although the latter two goal regulations imply exchange rate control factors, it can also be seen that the exchange rate has never been the main goal of monetary policy. In order to prevent the depreciation of the local currency, South Korea and Japan recently restarted the currency swap agreement that had been put on hold for eight years. The two sides will implement a currency swap totaling US$10 billion in the next three years. In addition, South Korea currently has foreign exchange reserves of more than US$400 billion, and Japan’s foreign exchange reserves are as high as US$1.25 trillion.

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