(Bloomberg) -- Foreign investors' love affair with the South Korean bond market is being tested by rising hawkish commentary from global central banks and escalating tensions over North Korea.
Global funds pulled 2.7 trillion won ($2.3 billion) from South Korean notes on Monday, the biggest one-day outflow since at least 2011. While they jumped back in with purchases of 1.25 trillion won the following day, Australia & New Zealand Banking Group Ltd. says there's a risk of more withdrawals should policy makers worldwide follow their rhetoric with action.
“Flows into the Korean bond market won't be such an easy call,” said Irene Cheung, a Singapore-based strategist at ANZ. “When global yields go up, it's going to affect the lower-yielders in the region and Korea is one of those markets.”
Currency weakness is another risk for overseas funds, who have poured $21.8 billion into the nation's bonds this year, the highest inflows among eight Asian markets tracked by Bloomberg, as subdued inflation and faster economic growth boosted the attractiveness of fixed-income securities.
The won has gone from being Asia's best-performing currency in the first quarter to its worst in the three months ended June 30, and Pictet Asset Management is predicting more losses after North Korea said Tuesday it launched an intercontinental ballistic missile. The currency dropped 0.6 percent on Thursday, the most in the region, and fell to as low as 1,157.85 per dollar, its weakest level since March 10.
The news of the ICBM “in particular” is “significant because it's definitely raised it to a new level,” said Simon Lue-Fong, London-based head of global emerging debt at Pictet Asset. “It's quite possible that we could carry to 1,200. That's where we were going” and that's “where it's peaked a couple of times before,” he said.
The cost of insuring against a default in South Korea's sovereign or corporate debt rose to near a seven-week high Wednesday on concern any fallout in the local economy may affect the government's fiscal strength. Investors have lost 0.6 percent on the nation's sovereign bonds in the past one week, the worst performance in emerging Asia, indexes compiled by Bloomberg show.
The outflow on Monday may have been led by selling by Franklin Templeton Investments, said analysts at NH Investment & Securities Co. and Shinyoung Securities, who looked at previous holdings of the money manager's funds. Templeton doesn't comment on its individual securities or what its investment teams may be actively buying or selling, Singapore-based spokeswoman Melissa Tan wrote in an emailed response to questions.
The yield on the Asian nation's 10-year sovereign notes climbed nine basis points last week, the most since November, halting four straight weeks of declines. It has risen another six basis points this week to 2.29 percent on Thursday. Global funds sold another 57 billion won of debt on Wednesday, according to data compiled by Bloomberg.
“There's a lot of geopolitical noise in the case of Korea and the market is concerned about what's happening,” said ANZ's Cheung. “Dollar/won has rebounded as well this week. When global yields go up and the currency loses its ground, it won't be a supportive environment for Korean bonds.”
--With assistance from Lilian Karunungan Whanwoong Choi and David Finnerty
To contact the reporter on this story: Liau Y-Sing in Kuala Lumpur at yliau@bloomberg.net.
To contact the editors responsible for this story: Tan Hwee Ann at hatan@bloomberg.net, Shikhar Balwani
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