S.Korea's rate hike prices top expectations, Bloomberg valuations turning attractive

S.Korea's rate hike prices top expectations, Bloomberg valuations turning attractive

The market has overpriced how much the central bank in emerging Asia is going to raise rates, as shown by the fact that Bloomberg valuations are starting to turn attractive for South Korea bonds.

Won forward rates are pricing in more than 125 basis points of hikes over the next six months, far above economists' predictions for how much the Bank of Korea will move. This indicates an improving environment for won bonds, the biggest loser among emerging-Asia s sovereign debt this quarter, as inflation quickened to a 14-year high and bets on rate increases jumped.

There may be an increase in flows into Korean debt that could help ease pressures on the won, which last week reached a 13 year low. The country is vulnerable to soaring imports exacerbated by a weak currency. It means that Korean bonds may start to diverge from other emerging markets in Asia, where the risk of interest-rate swaps and yields moving higher is weighing on the outlook.

Read: Traders Price In First Ever 50 Basis-Point Hike by South Korea

Foreign flows into Korean rates were the lowest in the last three months of 2020, at $15.7 billion, according to data as of June 29.

The Bank of Korea has increased rates by 125 basis points since the year, but the most Asian central banks, policy makers in Thailand and Indonesia are keeping their benchmarks at record lows, despite the fact that the Bank of Korea has increased rates by 125 basis points. Bank Negara Malaysia has only hiked by 25 basis points and is scheduled to review rates next July 6.

More hawkish bets for the BOK have pushed up interest-rate swaps in the past few weeks, despite the fact that they have not only dragged on won bonds. Korean won two-year non-deliverable interest-rate swaps that went to the highest in more than a decade this month, as did five-year swaps.

Goldman Sachs Group Inc. is calling for a receiver on the two-year swaps that would profit when rates decline, saying in a note Friday that they have overpriced rate hike expectations. The US bank paired this trade with a pay on equivalent Hong Kong dollar swaps to hedge global rate volatility.

In a research note last week, Citigroup Inc. said it spositioned for South Korea's expected rate trajectory to be overtaken by the US in the months ahead. It is underweight in most Southeast Asian notes.

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