Foreign investors’ appetite for Korean bonds peak with FX arbitrage appeal

2019.07.05 13:27:51 | 2019.07.05 13:28:10

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Foreign appetite for Korean bonds hit fresh peak in June as foreign exchange arbitrage added appeal to Korean debt in a rally on deteriorating economic outlook and speculation on rate cut.

According to the Financial Supervisory Service on Thursday, foreign investors held a record high of 125.38 trillion won ($107.2 billion) worth of Korean bonds as of July 3. The offshore investors net purchased 7.2 trillion won worth of Korean bonds in May, the largest-ever amount for a month in 11 years, and then bought additional 5.3 trillion won worth in June despite jump in bond prices.

The yield of government bonds dated from three to 50 years has fallen to fresh lows with the three-year paper yielding at 1.401 percent and the 50-year at 1.543 percent, far pricier than the overnight rate of 1.75 percent. The yield and bond price moves in opposite direction.

Offshore investors had been net sellers in Korean bond during the first two months of this year but turned as net buyers since March amid widening bets on lowered rates. Since then, their bond holding balance has surged by 13 trillion won.

Offshore investors also turned to debt in Korea amid shaky outlook on equities due to widening trade war. Arbitrage gains from the weak Korean won against the U.S. dollar also added appeal.

Eugene Investment & Securities pointed out that short-term debts with a maturity of two years or shorter, which give more arbitrage trading opportunities, account for 93 percent of entire won-denominated bonds held by foreign investors.

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A foreign investor must exchange foreign currencies to Korean won to invest in won-denominated debts, a process in which they can gain premium from trading. The currency swap spread fell to minus 1.5 percent in May when foreign investors’ purchase of Korean bonds hit a record high.

With a negative swap spread, foreign investors have exchange gains from investing in Korean won-denominated assets. But the positive swap rate means that foreign investors have to pay a premium to Korean won sellers when exchanging foreign currencies to the Korean won.

Market experts anticipate foreign investors would slow down their purchase of Korean debts as the swap spread has recently rebounded, but any massive sell-off is unlikely because demand for bonds is steady on high expectation for rate cuts across the world.

The value of Korean currency against the U.S. dollar had gained 2 percent over the last one month.

By Hong Hae-jin and Cho Jeehyun

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