Korea Treasury Bonds: Outperformance ahead
- There is significant scope for Korean bonds to outperform US Treasurys in the short term
- Price pressures in Korea have fallen significantly over the past few months.
- Comparatively, the US may be facing upside risks to inflation
- In short, Fed tightening may be much more compelling than Bank of Korea tightening this year
- Moreover, the strength of the won may actually deter the BoK from frontloading rate hikes
There is significant scope for Korea Treasury Bonds (KTBs) to outperform US Treasurys (USTs) in the short term. The KTB curve has re-correlated with the UST curve in recent months. In terms of the level and steepness, both curves are virtually identical up to the 10Y tenor. Beyond that, there is a divergence with 30Y USTs yielding 40bps more than 30Y KTBs. Some of the yield gap is probably aggravated by the inversion in the 10Y/30Y segment of the KTB curve. We think that 2Y-10Y KTBs are likely to fare better than comparable USTs in the coming months.
Price pressures in Korea have fallen significantly over the past few months. Headline CPI is now at 1.0% YoY in January, compared to 2.6% in August. Going forward, the strength of the Korean won (keeping imported inflation muted) and favourable base effects should keep a lid on headline CPI. Comparatively, the US may be facing upside risks to inflation. US CPI has stayed at-or-above 2.0% YoY since September. In addition, core CPI and wages appear to be picking up.
In short, Federal Reserve tightening may be much more compelling than Bank of Korea (BoK) tightening this year. Moreover, the strength of the won (the USD/KRW is down by 6.7% since October) may actually deter the BoK from frontloading rate hikes. Our forecasts also reflect a much more dovish tightening profile for the BoK (three hikes by end-2019) compared to the Fed (five hikes).
Lastly, there have been signs of thawing tensions between South Korea and North Korea. Investors were understandably spooked in 2017 when relations between the two sides were aggravated by the North’s multiple missile launches. Unsurprisingly, foreign ownership of KTBs took a tumble over the past six months. However, with cross currency basis swaps (2Y-5Y) incredibly attractive, offering between 62-67 bps in pickup, we think that USD-based investors may return.
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Rates Strategist - G3 & Asia
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