Inflation Wave Will Punish South Korean, Thai Bonds Most in Asia

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Bonds in South Korea and Thailand appear to be the most at risk in Asia as U.S. inflation expectations increase, according to a Bloomberg study.

Debt from the two nations has been the most sensitive to past episodes when American break-even rates have jumped, based on five past scenarios starting in 2011. Korea’s bonds showed a z-score -- which measures the relationship to the mean -- of 0.81, while Thailand’s is 0.77. That compares with just 0.09 for China and minus 0.01 in India.

The vulnerability of Korea and Thai bonds can be attributed to the tight spread of their yields over U.S. Treasuries, and also their susceptibility to imported inflation due to their relatively high reliance on energy imports.

Inflation Wave Will Punish South Korean, Thai Bonds Most in Asia

Inflation expectations are ratcheting higher around the world as record central-bank stimulus has created a mountain of liquidity that is starting to filter through into consumer prices. The U.S. 10-year break-even rate, which measures expectations for future inflation, climbed to as high as 2.59% this week, from just 0.47% in March last year. Those concerns escalated this week with faster-than-expected U.S. inflation figures for April.

“We could get higher break-evens and higher nominals if the Federal Reserve not only lets inflation overshoot, but also allows the U.S. economy to run hot,” said Duncan Tan, rates strategist at DBS Bank Ltd. in Singapore. “This scenario is less clear cut, but should be marginally detrimental to emerging Asia bonds, he said.

Real Yields

The story is somewhat different in terms of real yields. A similar Bloomberg analysis of periods of rising inflation-adjusted yields in the U.S. -- driven by optimism over growth and expectations for Fed normalization -- show Indonesian bonds have been the most vulnerable, with a z-score of 4.51, followed by Thailand at 2.69.

A jump in U.S. real yields tends to boost the dollar, which has a relatively large impact on the high-beta rupiah. Indonesia’s currency weakened about 4% on average during the five periods used for the study, compared with an average of 2% for its five Asian peers.

Inflation Wave Will Punish South Korean, Thai Bonds Most in Asia

It appears therefore that the immediate outlook for emerging Asian bonds will differ depending on whether there is a bigger move in the U.S. in break-even rates or real yields. Whichever it is, all the signs suggest there will still be plenty of focus on CPI data for the foreseeable future.

Note: The findings of the study are summarized below

Sensitivity to U.S.

Break-Even Rates

Z-score

BP move for each

1bp move in U.S.

Sensitivity to U.S.

Real Yields

Z-score

BP move for each

1bp move in U.S.

South Korea0.810.51Indonesia4.511.26
Thailand0.770.77Thailand2.692.69
Malaysia0.650.61South Korea1.430.57
Indonesia0.450.51Malaysia1.120.76
China0.090.03China0.630.12
India-0.01-0.01India0.320.17

Methodology

  • The study measures the impact on emerging-Asia bonds from significant moves in U.S. break-even rates and real yields during five scenarios since 2011
  • A shock move in U.S. asset prices is defined as an average 30 basis-point move in break-evens over a 10-day period, or a 54 basis-point jump in real yields over the same timescale

©2021 Bloomberg L.P.

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