Korean Bonds Fall as Higher U.S. Treasury Yields Cool Demand; Won Advances

South Korea’s five-year bonds dropped for a fifth day, the longest losing streak in seven weeks, as rising returns on U.S. Treasuries eroded the attraction of higher-yielding assets.

The decline and gains by the won also came after manufacturers’ confidence in South Korea improved for the first time in four months, damping concern economic growth will slow. Fifteen minutes before trading in the currency and bonds closed, a South Korean official said the government plans to tighten a cap on overseas banks’ holdings of foreign-exchange derivatives to 200 percent of equity capital from 250 percent currently.

“Korean bonds are reflecting the weakness in U.S. bonds we saw overnight,” said Peter Park, a fixed-income analyst at Woori Investment & Securities Co. in Seoul. “We’re also seeing an impact on Korean yields from investor expectations of a continuing economic recovery.”

U.S. Treasuries tumbled yesterday after a $35 billion sale of five-year notes attracted the weakest demand in six months.

The yield South Korea’s 4 percent notes due September 2015 advanced three basis points to 4.09 percent in Seoul, the highest level in more than a week, according to the Korea Stock Exchange. The rate on similar-maturity U.S. government bonds climbed one basis point to a seven-month high of 2.16 percent, following a 12 basis-point jump yesterday, according to data compiled by Bloomberg. A basis point is 0.01 percentage point.

U.S. Debt

U.S. debt due in more than a year is headed for the biggest monthly loss in global government bond markets amid signs a recovery in the world’s biggest economy will be sustained. U.S. retailers’ 2010 sales jumped 5.5 percent to $584 billion from Nov. 5 through Dec. 24, MasterCard Advisors’ SpendingPulse said yesterday.

An index tracking expectations of South Korean manufacturers for the month ahead rose to 92 from 91, the Bank of Korea said today. A measure of non-manufacturing companies’ expectations fell to 87 from 92. A reading below 100 indicates respondents are more pessimistic than optimistic.

The government plans to tighten the cap on domestic banks’ holdings of foreign-exchange derivatives to 40 percent from 50 percent, said the official, who declined to be identified because the plan isn’t public yet. The finance ministry will announce the changes in January, he said.

“It didn’t seem like the derivatives report had any real affect on trade,” said Charles Han, Hong Kong-based head of foreign-exchange trading at Newedge Financial HK Ltd. “It could be a stepping stone for something larger down the line.”

Security Tension

The currency has gained 1.1 percent this month, after sliding 2.9 percent in November, when North Korea fired artillery at an island in the South causing four deaths. The South’s defense ministry today labeled the North’s regime and military an enemy, stopping short of using the term “main enemy.”

The won advanced 0.1 percent to 1,146.35 per dollar as of the 3 p.m. close in Seoul, according to data compiled by Bloomberg. It earlier touched 1,143.45, the strongest level since Dec. 15. The currency gained 1.5 percent this year and is forecast to appreciate 9.2 percent by the end of 2011.

“The won has been on a stronger path amid signs of a recovery,” said Kim Jin Ju, a currency dealer at Korea Exchange Bank in Seoul. “But geopolitical risk still lingers, and Europe’s debt crisis is not a done deal.”

To contact the reporters on this story: Frances Yoon in Seoul at fyoon2@bloomberg.net.

To contact the editor responsible for this story: Sandy Hendry at shendry@bloomberg.net.

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