It's the current account stupid: Korea, Thailand lure flows

[SINGAPORE] When it comes to Asian bonds right now, getting the highest yield doesn't seem to be the top priority. As investors pile back into emerging debt, the two nations luring the most money have some of the lowest rates.

Foreign funds have pumped US$3.6 billion into South Korean sovereign notes in 2017, the most in developing-nation Asia, while the US$2.2 billion of flows into Thailand are the largest since the same period in 2013. Along with Taiwan, where there's no comparable figures available, the two countries are the only emerging markets in the region with 10-year yields of less than 3 per cent.

What they also have in common are large current-account surpluses, hefty foreign-reserve stockpiles and some of the region's lowest inflation rates. That's putting them in a good position to cope with Federal Reserve interest-rate increases later in the year and a possible resumption of the US dollar's rally.

"Thailand and South Korea are among favourites, maybe because of the bullish outlook for their currencies given their large current-account surpluses," said Jun Kato, a senior fund manager in Tokyo at Shinkin Asset Management Co, which oversees about US$8.9 billion. The surpluses add appreciation pressure to the won and the baht at a time when the Trump administration is criticising nations that it perceives have currencies that are too weak, he said.

The won is the best Asian emerging-market performer this year, strengthening 5.1 per cent against the US dollar. Next is the currency of Taiwan, which also runs a current-account surplus, and the baht, with respective gains of 4.1 per cent and 2.1 per cent.

The currencies of Asian developing nations with large external surpluses have beaten the rest amid the unwinding of the so-called Trump trade, partly due to the regional authorities' concerns about being named currency manipulators, Qi Gao, a foreign-exchange strategist at Scotiabank in Singapore, said in a note released Feb 9.

Some of the economic indicators making South Korean and Thai bonds attractive include: Thailand's current-account surplus was 12 per cent of gross domestic product in the third quarter of 2016, while South Korea's was 7.25 per cent.

Only Taiwan had a larger excess among Asian emerging markets South Korean exports climbed 11.2 per cent in January from a year earlier, the biggest increase since 2012. Thailand reported strong export growth figures in November and December, and Goldman Sachs Group Inc last week raised its 2017 GDP growth estimate for the nation to 3 per cent from 2.4 per cent Thailand's foreign-exchange reserves have risen 5 per cent to US$180.4 billion this year, giving it a bigger stockpile than Malaysia and the Philippines combined. South Korea is sitting on US$374 billion of reserves South Korea and Thailand had inflation of 2 per cent and 1.6 per cent in January, among the lowest in emerging-market Asia.

Although both economies have seen inflation quicken markedly in the past few months  Korean bonds are in some sense a safe haven within Asia and are being favoured in the current defensive environment, said Ashley Perrott, head of pan Asia fixed income at UBS Asset Management in Singapore. Thailand's debt market is driven more by locals, with domestic buying of long-dated notes from December aiding performance and luring more foreign money, he said.

As parts of the Trump trade unwind, US dollar weakness and falling Treasury yields have enticed investors back into South Korean and Thai bonds, said Eugene Leow, a fixed-income strategist at DBS Group Holdings Ltd in Singapore. The nations' large current-account surpluses bolster belief their debt will be supported, although the uptick in inflation bears watching, he said.

South Korea is also one of the economies most vulnerable to a rise in trade protectionism from the US and could be hurt if the Trump administration tries to renegotiate the free-trade agreement between the two nations.

While a gauge of the US dollar fell 2.6 per cent in January after rising 7.2 per cent over the previous three months, the market consensus for two or three Federal Reserve rate increases this year is likely to fuel further gains in the greenback. President Trump's promised tax cuts and any pickup in infrastructure spending in the US will also be supportive and might lead to a faster pace of rate increases.

South Korea and Thailand are well positioned to benefit from this, said Alexander Wolf, a senior emerging-market economist at Standard Life Investments Ltd in Hong Kong.

"In the event that you do see fiscal stimulus in the US that's stronger than expected, you see inflation pick up and you see the Fed move more quickly," he said. "Then the ones with large-current-account surpluses stand out as the least exposed to a tightening US dollar."

BLOOMBERG