Korea paying a price for falling cost of staples

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Korea paying a price for falling cost of staples

Plunging costs for staples from kimchi to gasoline are adding to record losses on inflation-protected notes, and Korea’s biggest bond fund manager is cautious.

So-called linkers have lost 5.3 percent in the nation this year, the worst performance in Bank of America Merrill Lynch indexes since 2011. That exceeds the 4.5 percent loss on similar debt globally. Expectations for inflation to remain near a 14-year low will continue threatening returns, according to Samsung Asset Management, which oversees 89 trillion won ($84.7 billion).

“There’s not enough interest in inflation-linked bonds,” said Lee Do-yoon, Seoul-based head of the fixed-income division at Samsung Asset. “There’s low liquidity, they’re poorly valued and they offer low returns. Plus investors expect inflation to remain subdued for some time.”

While the won’s 8 percent gain against the dollar since June 30 has cut import costs, it has also lowered the competitiveness of exports and threatens to drag on economic growth. The break-even rate, which measures the price increases traders expect over the life of linkers, dropped 46 basis points this half to 1.76 percent, near a four-year low, according to data. That’s less than the central bank’s targeted inflation range of 2.5 percent to 3.5 percent through 2015.

The Bank of Korea kept its benchmark interest rate unchanged at a policy meeting Thursday, with low inflation giving it room to support a rebound in Asia’s fourth-biggest economy.

Consumer prices climbed 0.9 percent in November from a year earlier after a 0.7 percent increase in October that was the smallest gain since July 1999. Inflation has stayed below the central bank’s target range since May 2012.

The cost of kimchi has dropped to its lowest since 2009, according to an index tracking the prices of ingredients from the Ministry of Agriculture, Food and Rural Affairs.

“Due largely to the stability of international agricultural prices, inflation will remain low for the time being,” the Bank of Korea said in a statement after keeping the seven-day repurchase rate at 2.5 percent, where it has been held since a cut in May.

The yield on Korea’s 3 percent sovereign bonds due December 2016 climbed one basis point Thursday to 3.01 percent, Korea Exchange prices show.

The won is the best-performing Asian currency this half. It will likely end 2014 near that level at 1,055 and strengthen to 1,025 the following year, according to the median estimate in a survey.

“We don’t recommend buying linkers as investors are wary of the Bank of Korea’s inflation forecast,” said Lee Jung-bum, a strategist at Korea Investment and Securities, the country’s third-biggest brokerage. “The risk from buying the inflation-tied bonds is big amid expectations for the won to strengthen.”

Korea first introduced inflation-linked bonds in March 2007, with securities that pay interest twice yearly and link the coupon and final principal redemption to the headline inflation rate.

In an effort to revive the market, the government plans to propose incentives for inflation bonds in its sovereign note issuance plan for 2014 to be released in January, Kim Jin-myung, director of the Finance Ministry’s treasury bureau, said Nov. 27.

The linkers may get some help from the Federal Reserve, according to Heo Eun-han, a fixed-income strategist at Woori Investment and Securities. The U.S. central bank will likely start paring stimulus in the first quarter next year, according to the majority of economists surveyed by Bloomberg on Dec. 6. Woori Investment recommends buying the inflation-linked bonds following any Fed tapering, Heo said.

While any pick-up in inflation along with economic growth next year could leave linkers looking attractively priced, they aren’t at that point yet, Rohit Arora, Singapore-based emerging-market rates strategist at Barclays, wrote in emailed responses to questions.

“We do not expect an imminent pick up in demand for the Korean inflation-linked bonds,” Arora said.

Bloomberg

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