[Market Now] Foreigners sell bond futures on dashed expectations for liquidity injections

With expectations of a Korean version of quantitative easing dashed as Korea’s conservative Saenuri Party failed to grab the majority of seats in the general elections, net selling of bond futures by foreign investors hit a record high last week.

According to the Korea Exchange, foreign investors unloaded 6,856 contracts of 10-year Korean Treasury Bond Futures and 16,495 contracts of 3-year bond futures after the legislative election last week.

“Foreign investors changed their positions as the possibility of quantitative easing decreased after the election,” said Kang Seung-won, an analyst at NH Investment & Securities.

Saenuri Party lawmakers initially sought for a Korean version of market liquidity injections amid slower-than-expected growth for Asia’s fourth-largest economy.

Facing strong opposition from progressive parties including The Minjoo Party of Korea, conservative lawmakers pushed to revise relevant laws enabling the central bank to invest in bonds issued by the Korea Development Bank and Korea Housing Finance Corp. Given those fixed-income securities are not guaranteed by the central government, the Bank of Korea cannot acquire those bonds.

As Saenuri Party gained less than a three-fifths majority in the National Assembly, market observers are saying that its plan for liquidity injections is practically unachievable.

Also, expectations of a lower benchmark interest rate by the central bank had further spurred the selloffs of state bond futures. Without more money pumped into the markets, coupled with a lower rate on weakening growth, bonds will bound to lose demand as investors seek higher-yielding investment assets on a loose monetary policy.

The Bank of Korea is expected to revise its growth forecast in line with other agencies, including the International Monetary Fund, which slashed their outlooks to around 2 percent. The central bank projected 3 percent growth earlier this year, similar to that of the Ministry of Finance.

Last Wednesday’s loss by the Saenuri Party to progressives Minjoo Party and People’s Party is expected to further weaken Korea’s growth as it poses a challenge to the incumbent administration’s reform efforts, Moody’s said.

“The (Saenuri) Party’s loss of its plurality in parliament will make it more difficult for President Park Geun-hye to pass proposed structural reforms. This is credit negative because a lack of reforms threatens to weigh on Korea’s growth outlook,” said Shirin Mohammadi, an associate analyst at Moody’s Investors Service, in a report.

“The weakening prospects for structural reform implementation come at a time of persistent external headwinds in the form of slowing growth in China and weak domestic consumer confidence.”

Moody’s expects Korea to grow 2.5 percent this year.

By Park Hyong-ki (hkp@heraldcorp.com)