On Aug. 14, data showed that foreign investors made a net sale of $960 million in Korea Government Bonds in July. The shift to net selling is the first in three months since Government Bonds were included in the World Government Bond Index (WGBI) in April.
Experts say it is because Korean bonds have become relatively less attractive compared with U.S. bonds. Not only are U.S. bond yields higher, but the currency "arbitrage incentive" that foreign investors gain by converting dollars into won to invest has also decreased.
According to the Bank of Korea on this day, foreigners made a net purchase of $550 million in Korean Government Bonds in April, when WGBI inclusion took effect. The net purchase amount increased to $5.68 billion in May, then decreased to $1.65 billion in June, and turned to net selling in July.
One reason foreigners made a net sale of Government Bonds is relatively lower yields compared with other countries. As of the day, the 10-year Korean Government Bonds yield was 4.29%, lower than the United States (4.65%). Short-term market rates were also lower in Korea (KOFR 90-day average 2.6%) than in the United States (SOFR 3-month 3.74%).
U.S. Government Bonds yields have been on an upward trend since early this year as concerns grew over the expanding federal fiscal deficit. Recently, as analysis gained traction that the Federal Reserve effectively ended rate cuts, yields have risen further. In Korea, yields also climbed on growing expectations for a base rate hike, but the increase has been relatively smaller than in the United States.
Recently, the ample supply of dollars in the foreign currency funding market has also increased preference for U.S. products over Korean ones. Foreign investors often lend dollars they hold in the foreign currency funding market, receive won, and invest in Government Bonds. In doing so, they can receive a premium (swap rate) as compensation for lending. This swap rate determines bond investment revenue.
The "arbitrage incentive (interest rate differential minus swap rate)," which shows whether it is worth it for foreigners to invest in Korean bonds, has been negative every day from on the 21st of last month to on the 13th for 3-month tenors. This indicator was positive from January to May this year, but there were more negative days starting in June. It is an effect of increased foreign currency liquidity.
If the current situation continues, there are projections that foreigners' net selling of bonds could widen. A Bank of Korea (BOK) official said, "If the current situation continues, there could be more outflows focused on short-term funds," and added, "It will depend on conditions in the foreign currency funding market."