Foreign bond investors fearing further rate cuts

The prospect of more interest-rate cuts in Korea is putting off foreign bond investors worried about the falling won and a narrowing yield advantage over U.S. debt.

Foreign funds were net sellers of local currency sovereign bonds last month for the first time in data going back to mid-2011, as the won weakened 4.7 percent in Asia’s worst performance. The median yield premium investors demand to hold 10-year Korean notes over U.S. securities was 13 basis points in July, down from 27 basis points in the first half.

“The pressure for another rate cut is actually rising,” said Arthur Lau, the Hong Kong-based co-head of emerging markets fixed income at PineBridge Investments, which oversees $78.1 billion. “We’ve turned neutral from overweight on Korean bonds, in view of poor economic activity such as Middle East respiratory syndrome (MERS), weak exports and slowing Chinese growth.”

Four interest rate cuts over the past year haven’t been able to revive an economy where exports have fallen every month in 2015, just as consumer demand was dented by the deadly MERS virus. Daewoo Securities, Korea’s biggest brokerage, sees full-year expansion at 2.5 percent, less than the central bank’s latest estimate of 2.8 percent and 3.3 percent in 2014.

The Bank of Korea lowered its benchmark rate by one percentage point to 1.5 percent in a series of moves from August 2014 through June. The monetary authority has cut its 2015 economic growth forecast three times since the beginning of the year, when it projected 3.9 percent expansion.

While only three of 23 analysts surveyed by Bloomberg in July see another reduction before year-end, Yoon Yeo-sam, a fixed income analyst at Daewoo in Seoul, doesn’t think the easing cycle is over.

“I don’t see any strong driver for growth at the moment,” he said. “This points to the need for the BOK to cut.”

The won has dropped 7.8 percent against the dollar over the last three months, the most in Asia, and fell to a three-year low last week. The rate cuts have helped push the yield on 10-year government bonds down 70 basis points in the past year to 2.40 percent, Korea Exchange prices show. Foreign funds pulled a net $156 million from won sovereign debt last month, according to Financial Supervisory Service figures.

“The main reason for the drop in bond holdings is the weak won,” said Kwon Do-hyun, a Seoul-based analyst at the Korea Center for International Finance, a government-funded research institute. “The narrowing spread between U.S. bond yields has also reduced the allure of Korean debt,” and there’s a risk of more outflows this year, he said.

While the falling won is affecting foreign sentiment, the currency hasn’t dropped enough to warrant a change in the general attractiveness of Korean assets, said Luke Spajic, the Singapore-based head of Asia portfolio management at Pacific Investment Management Company (PIMCO), which oversees $1.52 trillion.

“Investors are looking for a more pronounced move to make a clearer decision,” he said, adding that PIMCO was neutral on duration for the country’s bonds.

Although no additional MERS infections have been reported since July 4, BOK Gov. Lee Ju-yeol said July 22 that the economic impact of the disease would last through August. The government announced a 15 trillion won ($12.8 billion) supplementary budget last month to counter the fallout.

The additional spending will take a while to flow through to the economy, said Kong Dong-rak, a fixed income analyst at Korea Asset Investment Securities in Seoul.

“The economy isn’t reviving yet,” he said. “So the market has to ... push for another rate cut.” Bloomberg