Bond Market Instability
Asian capital is filling up a vacancy of U.S.-based Franklin Templeton, a big player in the domestic bond market. The expectation that foreign investors’ share in the won-denominated bond market will decrease due to Templeton going on a selling spree starting from the second half of last year was off the mark with the arbitrage transaction of Asian sovereign wealth funds and capitals. Rather, the total won-denominated bonds owned by foreign investors increased.
Market watchers believe that arbitrage investment will continue for a while after the U.S. Fed raised interest rates and recommend investors make a prudent investment as these funds are vulnerable to short term events. The domestic economic improvement and the government’s revised supplementary budget will be able to increase monetary market rates, adversely affecting the bond market.
According to investment banking industry sources on June 21, the balance of won-denominated bond holdings by foreigners stood at 103. 4 trillion won (US$90.65 billion) in the domestic bond market as of the 16th. Foreign investors net bought 1.2 trillion won (US$1.05 billion) worth of bonds last week from June 12 to 16, recording a net investment of 200 billion won (US$175.19 million) in the domestic bond market. Kang Seung-won, an analyst at NH Investment & Securities, said, “Last week, foreigners net bought 1.3 trillion won (US$1.14 billion) worth of short-term bonds, or those with maturities of two years or less. Despite hawkish remarks of Lee Ju-yeol, the governor of the Bank of Korea, foreign investors bought 1 trillion won (US$876.12 million) worth of short-term bonds with maturities of one year or less, showing a buying spree at low prices.”
The won-denominated bond market faltered due to the fund selling spree of Templeton, which has controlled the South Korean bond market for a long time, last year. The balance of won-denominated bond holdings by Templeton decreased by 60 percent last year alone and the company also redeemed bonds worth US$350 million (399.46 billion won) in the first quarter this year.
However, the balance of won-denominated bond holdings by foreigners, which showed a decline last year, started to increase owing to an inflow of Asian capitals. According to the Financial Supervisory Service (FSS), most foreign capitals flowed in the market after February are from Asian countries such as China, Thailand, Singapore, Malaysia, Australia and Japan as well as most of arbitrage transactions.
However, it is worrisome that these funds focus on short-term profits through arbitrage transactions. Arbitrage transaction is a financial operation consisting in making a profit from the difference in the prices of certain goods in different markets. That is, the goods bought in one market at low prices and sold at higher prices in another market. In the financial market, it refers the transaction that make profits by buying the same currency at low prices in a market and selling it at higher prices in another market when the same currency has the difference in exchange rates. Kang said, “This year, the balance of won-denominated bond holdings by foreigners increased by 14 trillion won (US$12.28 billion). Out of 14 trillion won (US$12.28 billion), 13.6 trillion won (US$11.93 billion) in terms of net purchase focused on short-term bonds with maturities of one year or less. It means that most of them are actually arbitrage transactions.”
Foreigners’ won-denominated bond investment is expected to be based on short-term arbitrage transaction for a while, rather than direction. Kang said, “The possibility of funds leakage in the future will be greatly affected by Asian currencies against the US dollar. As investors lowered guard toward the U.S. Fed’s move to raise interest rates and the flow of Asian currencies are expected to be stabilized, existing arbitrage transactions are least likely to be rapidly settled.”
There are mixed views on long-term flow. The government’s plans to draw up a revised supplementary budget and stimulate the economy can shrink the bond investment sentiment of non-Asian capitals. In fact, Bloomberg recently forecasted that the South Korean bond market will become weaker, citing foreign institutions. Nikko Global Asset Management said, “When the South Korean government shows a clear sign that can stimulate the economic growth, South Korean bonds will turn bearish in the medium and long term. Regarding the domestic bond market, Western Asset Management also said, “Funds to buy the won-denominated bonds are expected to decrease so it needs a risk management.”