South Korean bonds are attracting five times more foreign inflows than Japan, where stimulus measures have pushed yields to record lows and devalued the yen.
Overseas investors bought 37.9 trillion won ($36.5 billion) more listed Korean bonds than they sold in 12 months through April 4, up 4 percent from the prior year, while net purchases of Japanese debt dropped 85 percent to 738.4 billion yen ($7.2 billion), official data show. The won has strengthened 7.7 percent against the dollar in the past year, the most in Asia, compared with the yen’s 3.8 percent depreciation.
South Korea is emerging as a safe haven as a stronger and less volatile won, along with a record current-account surplus, offer investors including foreign central banks protection against market turmoil. Its sovereign debt is rated on par with Japan by Moody’s Investors Service, and data from the Financial Supervisory Service show Norway, Switzerland, Singapore, France and Israel increased holdings of Korean bonds this year.
“Korea is acting as a safe haven for the region,” Greg Gibbs, Singapore-based head of Asia-Pacific markets strategy at Royal Bank of Scotland Plc, said in an April 14 interview. “That’s consistent with a strong current-account position, which continues to improve, a moderate growth outlook and stable, improving internal debt levels.”
Asia’s fourth-largest economy may expand 4 percent this year, the fastest since 2010, Finance Minister Hyun Oh Seok predicted April 12. That matched the Bank of Korea’s estimate, which was raised last week from 3.8 percent.
South Korea’s current-account surplus, which reached an all-time high of $80 billion in 2013, widened to $4.5 billion in February, marking the 24th straight month in the black, official data show. Japan’s broadest measure of trade last year had its smallest excess since 1983 based on International Monetary Fund data and the country reported a record deficit of 1.6 trillion yen in January, government data shows.
Short-term external debt, a key source of outflows from South Korea during the 2008 global financial crisis, fell to $113 billion at the end of 2013, and has slid every year from $160 billion in 2007. The nation’s default risk is the lowest in the region after Japan and its currency reserves rose to an unprecedented $354 billion in March and exports jumped 5.2 percent, the most this year, according to official data.
South Korea’s debt market, Asia’s third largest and the region’s second-most active after Japan, was valued at $1.6 trillion as of end-2013, according to the Asian Development Bank. Global investors own 95 trillion won, or 6.7 percent, of listed bonds, FSS data show. Central banks account for 41.8 percent of the holdings, up from less than 10 percent in 2008, according to a government white paper for 2013.
“One of the main reasons why we have been structurally bullish on the won has been the change in the quality of foreign inflows into Korean bond markets,” Geoffrey Kendrick, head of Asian foreign exchange and rates strategy at Morgan Stanley in Hong Kong, said in an April 9 report. “The inflows into Korean bonds are becoming stickier,” he wrote, referring to purchases by central banks and sovereign wealth funds.
The won touched 1,031.55 per dollar on April 10, the strongest since August 2008, according to data compiled by Bloomberg. Kendrick forecast the won will climb to 950 in medium term. Its advance in the past year compares with losses for all other Asian currencies tracked by Bloomberg except the Hong Kong dollar, which has gained 0.1 percent.
Global funds bought $1.1 billion more Korean bonds than they sold in March, the most in eight months, while equities attracted $2.3 billion this month after last quarter’s $2.7 billion outflow. The cost to insure Korean debt against default for five years using credit-default swaps was 62 basis points on April 15, Asia’s lowest after Japan’s 46, CMA data show.
“The won is standing out as a relatively safe currency, and it’s not surprising that it continues to see demand,” Gibbs from RBS said. “It’s got a number of strong corporations producing strong exports. It also provides a bit of carry. That’s another reason it’s attracting demand from sovereign investors.”
The yield on South Korea’s 10-year government notes was 3.55 percent yesterday, while comparable Japanese debt yielded 0.605 percent, the lowest globally. The premium on the Korean notes over their Japanese counterparts reached 294 basis points, 18 basis points away from the highest since 2011 on Dec. 5, data compiled by Bloomberg show.
Japan’s bond yields reflect global demand for the yen, which remains undiminished, according to Mitsubishi UFJ Asset Management Co., a unit of the biggest Japanese financial group by market value.
The world’s third-largest economy had accumulated overseas assets worth $3.42 trillion on a net basis in 2012, the most among the 28 countries tracked by the International Monetary Fund.
The yen’s share of global foreign-exchange reserves climbed to 3.94 percent of total allocations in the final quarter of last year, from 3.88 percent in the preceding three months, IMF data show, backed by 33 years of current-account surpluses even though the nation has run fiscal deficits. Overseas investors bought a net 648 billion yen of Japanese debt last week, the latest government data showed today.
“Japan’s haven status hasn’t declined,” said Kiyoshi Ishigane, a Tokyo-based senior strategist at Mitsubishi UFJ Asset, which oversees more than $79 billion. “Japan’s fiscal deficits are big, but assets in the private sector are large enough to cover the shortfall, leaving the nation’s balance sheet in surplus.”
Investors tend to increase exposure to South Korea when the global markets become more risk averse, reflecting a “safe-haven flow,” IMF researchers wrote in a working paper this month. “It’s not unreasonable to speculate if a quantitative easing tapering takes place in an orderly fashion, portfolio capital flows are likely to continue,” it said, referring to the Federal Reserve’s paring of its monthly bond purchases.
The negative correlation between Korean sovereign yields and a gauge of volatility for U.S. equities reached an 11-year high last week.
The 60-day correlation with the Chicago Board Options Exchange Volatility Index reached minus 0.30 on April 8, the highest since 2003, signaling an increase in the degree to which the two move in opposite directions. The VIX is derived from options on shares in the Standard & Poor’s 500 Index. Known as the fear gauge, it tends to rise during periods of financial stress that are often accompanied by market declines.
“Investors have recognized that South Korea is a developed economy with a large, liquid government bond market,” Rajeev De Mello, who manages $10 billion as head of Asian fixed income at Schroder Investment Management Ltd. in Singapore. South Korean bonds “remain a core part of our portfolio. Central banks and sovereign wealth funds in current-account surplus countries maintain their diversification targets, and I expect some of these reserves to also be invested in South Korea.”