Inflows Into South Korean Bonds Surge

  • Nikko Asset says it will turn more bearish if growth improves
  • Won seen as second worst emerging Asia currency by year-end

Investors have been piling into South Korean bonds at the fastest pace in four years. That may not be such a good idea, according to Nikko Asset Management Co. and Standard Chartered Plc.

Clouds are looming over Asia’s third-biggest debt market including a stimulus package being planned by new President Moon Jae-in, a Federal Reserve intent on increasing U.S. interest rates and forecasts for the won to weaken. Korea’s 10-year bond yield will climb to the highest since 2015 by the end of December, according to a Bloomberg survey.

“In the medium to longer term, we will start to turn more bearish on Korea bonds if we see firmer signs that the new Moon administration is able to spur strong and sustainable growth,” said Edward Ng, a fixed-income portfolio manager in Singapore at Nikko Asset, which oversaw $183 billion at the end of March.

Overseas investors have boosted holdings of Korean debt by $20.6 billion this year, the most since the same period in 2013, encouraged by a rally in bonds around the world and signs global inflation is slowing. Korea’s 10-year yield fell from as high as 2.32 percent in March to 2.16 percent last week.

The inflows may have come at a bad time as President Moon, who took office in May, has proposed an 11.2 trillion won ($9.9 billion) supplementary budget to create 86,000 new jobs, improve working conditions and raise wages. While the stimulus may not be approved by lawmakers as his Democratic Party holds just 40 percent of seats in parliament, the plan is adding to positive sentiment spurred by a recovery in exports.

The central bank predicts inflation will accelerate to 1.9 percent in 2017, the fastest pace in five years, on the back of a recovery in oil prices.

“We think long-end rates will move higher on an export recovery, an uptick in inflation, easing geopolitical tensions and lower demand for structured products,” said Kathleen B. Oh, Korea economist at Standard Chartered in Seoul. “We would not expect further aggressive demand due to the June Fed meeting and expected rate hike this week but stable flows may continue.”

Korea’s 10-year yield will climb to 2.40 percent by year-end, which would be the highest since August 2015, according to the median estimate in a Bloomberg survey. It was at 2.19 percent as of 11:03 a.m. in Seoul.

Predictions for the won to weaken will also weigh on demand from overseas investors who hold about 10 percent of the nation’s government debt, according to the latest data from the Asian Development Bank.

The won has weakened 1.4 percent after climbing to a five-month high against the dollar at the end of March. It will fall another 2.7 percent by year-end, making it the second-worst emerging Asian currency during the period, according to Bloomberg surveys.

Further tightening by the Fed will put pressure on the won to keep weakening, said Gao Qi, a foreign-exchange strategist at Scotiabank in Singapore, predicting it will depreciate to 1,160 per dollar by year-end. The won will underperform other Asian emerging market currencies in this environment because of its higher volatility, he said.

Western Asset Management Co. expects inflows into Korean bonds will slow as the won weakens, although heavy selling is unlikely.

“A good degree of Asian investors remain benchmarked to Asian local currency indices of which Korea is a part, and Korea has recently served as a safe-haven play of sorts,” said Wontae Kim, a Singapore-based research analyst at Western Asset, which oversaw $433 billion at the end of March. “So, cutting positions and/or managing risk? Yes. Complete rotation away from Korea? No.”

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