‘Linkers’ find favor as consumer prices rebound

Korea’s inflation-protected bonds, or “linkers,” are finding favor with money managers as gains in consumer prices rebound from a 16-year low.

The linkers ended two months of losses to earn 1.2 percent in June, the most in a year, according to Bank of America Merrill Lynch indexes. The break-even rate, a measure of inflation traders expect over the life of linkers maturing in June 2025, has risen to 0.82 percent from a record 0.33 percent on March 19. Mirae Asset Global Investments predicts an advance to 1 percent by year-end, making the notes attractive.

“Demand for linkers will increase as worries over deflation ease,” said Kim Ki-hyun, managing director for fixed income at Kiwoom Asset Management, which oversees 26 trillion won ($22.6 billion). Kim said he plans to add to the firm’s holdings of inflation-protected bonds.

Gains in Korea’s consumer prices accelerated for a second month in June after the central bank cut interest rates to a historic low and global oil prices rebounded. Bank of Korea Gov. Lee Ju-yeol said on July 9 he expects inflation to quicken in the second half as a drought boosts food costs.

The inflation rate slid to 0.4 percent in March and April, the lowest since 1999, as the economy slowed and cheaper oil cut energy costs. It climbed to 0.7 percent in June, and Lee predicts an advance to 1 percent in the fourth quarter. The BOK this month maintained its forecast for price gains to average 0.9 percent in 2015, while cutting its growth estimate.

The Finance Ministry sold 802 billion won of linkers in the first half, 29 percent more than in the same period of 2014, when inflation reached a two-year high of 1.7 percent.

“In terms of issuance, inflation-protected bonds fared relatively well even amid low inflation,” said Kim Hye-cheon, a director at the ministry’s treasury bureau. “We expect sales will be reinvigorated going forward.”

The notes largely appeal to long-term investors because the market for the securities is illiquid, according to Hana Daetoo Securities.

“Institutional investors, who typically have a shorter investment horizon, would find it difficult to exit the market,” said Shin Dong-jun, chief strategist at Hana Daetoo in Seoul.

The BOK cut its policy rate to an unprecedented 1.5 percent in June, the fourth reduction since August. The authority kept the benchmark unchanged this month, saying it will monitor the impact of earlier reductions as well as the government’s 22 trillion won stimulus package to counter the economic impact of the deadly Middle East respiratory syndrome (MERS) virus outbreak and a drought.

Linkers maturing in June 2025 yielded 1.68 percent on Monday compared with 2.47 percent for 10-year sovereign notes, Korea Exchange prices show.

NH Investment & Securities recommends buying the linkers by selling 10-year government bonds, betting that inflation will reach 1.7 percent by the year-end.

“Investing in linkers will be relatively more profitable than holding government bonds,” said Park Jong-youn, a fixed-income analyst at NH Investment. “Low inflation has been holding investors back, but the impact of cheaper oil will recede while the drought will push up crop prices.”

Bloomberg