Foreign funds buy most South Korean bonds

In two years, foreigners bought the most South Korean bonds as wagers on the central bank turning dovish were increasing with a deteriorating economic outlook for its largest trading partner.

In May, global funds bought $11 billion of Korean debt, the most since July 2021. Currency exchanges are also supporting the currency, boosting returns for foreigners.

China's weak data is causing fears of slowing growth for Asia's biggest economy and its impact on nations such as South Korea. The Bank of Korea has already halted interest-rate increases, with analysts predicting a cut later this year as the country narrowly skirted a recession in the first quarter.

Korean exports to the country are expected to remain weighed, said Paik Yoon-min, a fixed-income analyst at Kyobo Securities, with no definite signs of China's PMI rebounding. The dominant view is that Korea's growth recovery will be delayed, and that is likely driving demand for Korean bonds. In May, China's economic recovery slowed, raising fresh worries about the outlook for growth. Manufacturing activity fell at a lower rate than in April, while services expansion eased, official data showed Wednesday, suggesting the post-Covid rebound had lost momentum.

In May, Korean six-month one-day spreads fell as much as 17 basis points, as dovish bets rose for the BOK, although they pared some losses in recent days.

Dollar-based investors in Korean bonds still have a significant advantage in terms of favorable cross-currency basis swaps. By offering in-demand greenbacks for the winning, they generate an extra 80 basis points on their investments, enhancing the returns on a five-year sovereign note to 4.8%. It compares with the average yield of around 3.60% for a similar-maturity Treasury in May.

There could be more foreign inflows, said Kiyong Seong, lead Asia macro strategist at Societe Generale Hong Kong branch. At this juncture, higher Korea rates and an apparent central bank pivot may also look attractive to investors, though we believe this could be a temporary trend, he said.