(Bloomberg) -- Traders are laying bets for South Korea’s interest rates to rise, but the market may have gotten ahead of itself in pricing in the hikes.
That’s the contention of global funds which are seizing the opportunity to pile into listed South Korean bonds. Net purchases swelled to a record $7.1 billion in the week ended June 11, taking inflows for the year to about $55 billion. Attractive returns have also boosted demand.
The Bank of Korea has handed bond investors plenty of trading opportunities in recent weeks as its signals on policy normalization lay the groundwork for what may be Asia’s first interest-rate hike this year. But opinion is divided on the rate outlook, with some strategists noting that employment is still below pre-pandemic levels and a majority of the population yet to be vaccinated.
“Current market rates look a bit too high given that it isn’t time yet to raise rates,” said Woo Hye-young, fixed-income analyst at eBEST Investment & Securities Co. “The pace of vaccination in South Korea is slower than the U.S., while hundreds of coronavirus cases continue to be found every day and inflation isn’t expected to be as strong either.”
Swap markets are pricing in three 25-basis point rate hikes from the Bank of Korea over the next year, the first of which is expected by end-2021.
Even if interest rates do rise this year, it’s worthwhile noting that during previous periods of tightening, swap rates in Korea have tended to peak close to the first rate hike, creating a window of opportunity.
Speculation of a tightening has gathered momentum as gains in services and retail sales cement the economy’s recovery from the outbreak. Exports surged the most since 1988 in May and a report due Monday may show shipments continued to climb in the first 20 days of June.
South Korea’s three-year bond yields have jumped back to pre-pandemic levels and climbed 35 basis points this year to around 1.33%. Dollar-funded investors can earn a slightly higher yield on the notes after hedging through cross-currency swaps, with a pick-up of over 100 basis points over similar-maturity Treasuries.
“The issue of BOK’s policy tightening -- the driver behind the latest weakness in bonds -- has likely come to an end,” said Kong Dongrak, fixed-income strategist at Daishin Securities Co. He expects just two rate hikes in total -- one in November and another some time in the latter half of 2022 -- with the presidential elections and low inflation among the reasons why rates are unlikely to rise more.
Below are the key Asian economic data and events due this week:
- Monday, June 21: Australia retail sales, Taiwan export orders, South Korea 20 days exports
- Tuesday, June 22: New Zealand consumer confidence, Malaysia foreign reserves, Taiwan unemployment rate, South Korea PPI
- Wednesday, June 23: Australia PMIs, RBA’s Ellis speaks, Japan PMIs, Thailand trade and BoT benchmark interest rate, Singapore CPI
- Thursday, June 24: Philippines overnight borrowing rate, South Korea consumer confidence
- Friday, June 25: China BoP current-account balance, New Zealand trade, Thailand foreign reserves, Singapore industrial production, Malaysia CPI, South Korea business survey
©2021 Bloomberg L.P.
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