Much dependency on China & Japan results in KRW’s depreciation

Long term perspectives:

Debt sustainability issues raise a big worry about the sustainability of Korean leverage.

Household mortgage loans rose 15.2% YoY in April to KRW 383 trn, marking high household debt at 10.8% YoY in April to a record KRW 535.6 trn.

With USD/JPY trading to a new 12 ½ year high, we anticipate an increased government regulatory actions on the KRW from government officials.

Cyclical data and JPY price action have returned focus on KRW's overvaluation. Meanwhile trade data was very disappointing.

Since South Korea has the highest export correlation and lowest export complementarities with Japan and China, KRW is going to be one of the biggest potential losers from continued JPY and CNY weakness which we expect USD/JPY end 2015 target of 132 and USD/CNY at 6.70.

We think the door remains open for further monetary easing of 25bps. Consensus expects only 10bps of cuts this year and rate hikes in early 2016. With the negative output gap continuing for longer than had been anticipated, we think those expectations seem too optimistic and KRW outperformance looks unsustainable.