South Korea's FX Swap Strategy and Its Implications for US Market Exposure

South Korea's recent recalibration of its foreign exchange (FX) swap strategies underscores a strategic pivot toward managing currency risk and stabilizing cross-border investments, particularly as it deepens economic ties with the United States. With the National Pension Service (NPS)—the world's third-largest pension fund—holding over 55% of its assets in overseas investmentsBank of Korea and National Pension Service Expand Currency Swap Agreement Amidst Declining Won^[4], the country has prioritized mechanisms to mitigate exchange rate volatility. By expanding its FX swap limit with the Bank of Korea (BOK) to $65 billion and extending the agreement until late 2025South Korea to ease foreign exchange regulations, expand FX market^[3], South Korea aims to reduce the NPS's reliance on spot market dollar purchases, which could otherwise exacerbate the won's depreciation. This move is critical given the won's 15-year low against the dollar in late 2024Bank of Korea and National Pension Service Expand Currency Swap Agreement Amidst Declining Won^[4], a trend amplified by the U.S. Federal Reserve's hawkish stance on interest rates and domestic political uncertainties.

The implications for U.S. market exposure are multifaceted. On one hand, South Korea's enhanced FX liquidity measures could facilitate smoother cross-border capital flows, benefiting U.S. investors seeking access to Korean assets. By easing foreign exchange regulations—such as raising forward foreign exchange futures position ceilings for local banks to 75% of capital holdingsSouth Korea to ease foreign exchange regulations, expand FX market^[3]—the government is signaling a commitment to liberalizing its financial markets. This aligns with broader efforts to simplify overseas capital-raising procedures and expand non-dollar trade settlementsKorea pushes for unlimited currency swap with U.S., but doubts emerge over feasibility^[1], which could diversify U.S. investors' risk profiles. However, the feasibility of an unlimited bilateral currency swap with the U.S. remains uncertain. Analysts note that Washington is unlikely to agree without additional incentives, given the limited benefits for the U.S. and South Korea's relatively underdeveloped FX market, where daily trade volume for the won ($142 billion) pales in comparison to Japan's ($1.25 trillion)Rising Foreign Exchange Hedging Costs Amid Interest Rate Reversals between Korea and the US and Potential Implications^[2].

From a strategic currency risk management perspective, South Korea's approach reflects a balancing act. While the expanded swaps with the NPS provide short-term stability, the persistent interest rate reversal between South Korea and the U.S. since July 2022 has inflated hedging costsRising Foreign Exchange Hedging Costs Amid Interest Rate Reversals between Korea and the US and Potential Implications^[2]. Forward exchange sales, a common tool for exporters and investors, have become more expensive, creating a divergence between hedged and unhedged fund returns. This dynamic could deter U.S. investors from committing capital to Korean markets unless hedging mechanisms improve. Conversely, the BOK's proactive measures—such as extending swap maturities and easing regulatory constraints—demonstrate a long-term vision to align with global financial standards, potentially attracting U.S. institutional investors seeking diversified portfolios.

For U.S. market participants, the key takeaway lies in South Korea's dual focus on liquidity management and regulatory reform. The country's efforts to stabilize the won while expanding cross-border investment channels present opportunities for U.S. firms to engage in Korean equities, infrastructure, and technology sectors. However, the success of these initiatives hinges on the U.S. agreeing to a more flexible swap arrangement or South Korea further liberalizing its FX market. As noted by a report from the Korea Capital Market Institute, the current hedging cost environment could persist until the interest rate differential narrowsRising Foreign Exchange Hedging Costs Amid Interest Rate Reversals between Korea and the US and Potential Implications^[2], a scenario that may take years to materialize.

In conclusion, South Korea's FX swap strategy is a calculated response to currency volatility and the demands of its $350 billion U.S. investment agreementKorea pushes for unlimited currency swap with U.S., but doubts emerge over feasibility^[1]. While the immediate benefits for U.S. market exposure remain conditional on geopolitical and regulatory developments, the country's commitment to enhancing foreign currency liquidity and market flexibility positions it as a strategic partner for cross-border investments. Investors should monitor the BOK's policy adjustments and the U.S. Treasury's stance on bilateral swaps, as these factors will shape the trajectory of South Korea's integration into global capital markets.