Global Recovery Trade Sees Korean Bonds in Investors’ Crosshairs

(Bloomberg) -- Investors positioning for a post-pandemic recovery have South Korean sovereign bonds in their crosshairs. They’re expecting won bond yields to be among the quickest to rise, with its economy on track for a sharp rebound.

The nation’s preliminary export data for December on Monday added to evidence of growth momentum after a 4% bounce year-on-year in November. The 10-year yield is already up about 20 basis points this quarter to around 1.7%, the second-biggest rise in the Asia Pacific after New Zealand, which has seen paring back of negative rate bets.

“A stronger pace of growth recovery, coupled with expansionary fiscal budgets beyond the pandemic time-line, should drive market expectations for Bank of Korea to be one of the first in the region to normalize policy,” said Duncan Tan, interest rates strategist at DBS Bank Ltd. in Singapore.

With the South Korean economy set to emerge from its first recession since 1998 next year, global funds have bought the nation’s stocks at the fastest pace in four years this quarter, helping the won top the Asian currency performers list. The economic optimism is reducing the appeal of safe haven sovereign debt and expectations are for bonds to fall further.

“A steeper curve has the upper hand next year,” said Kim Sanghoon, fixed-income strategist at KB Securities Co. Longer-tenor yields are set to rise further on a possible vaccine roll-out and larger supply, while the three-year remains gridlocked on rate hike expectations, he said, adding that the bear-steepening trade would also be valid for interest rate swaps.

There’s room for tightening bets with forward-dated interest rate swaps showing around 50 basis points of rate hikes over the next three-years, even as the BOK has pumped liquidity and slashed its key interest rate by 75 basis points to 0.5% in 2020. The correlation of the five-year swap to the six-month average export figures over the last decade also allows for recovery trades.

With the global business cycle increasingly made in China, South Korea is uniquely placed as China is the biggest trade destination for the nation’s products. China has already started talks on exiting stimulus but its relatively restrained easing also limits scope for tightening bets.

Data Monday showed exports rose 1.2% in the first 20 days of the month from a year earlier, with average daily shipments increasing 4.5% in the period, which had one less business day compared with last year.

This trend argues in favor of higher rates and a steeper Korean yield curve, which is already set in motion. Korean rates also tend to be roughly correlated to U.S. government bonds due to the nation’s trade linkages and consensus is almost unanimous for higher 10-year Treasury yields next year.

Key data due for the week:

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