Global Carry Trade and the Korean Interest Rate Market Oct 2010, KJ Choi

Deutsche Bank page 2 Carry trade in a low interest rate environment Maintaining zero target rate after 2008Inflows into EM debt funds Source: EPFR, DB Research Note: Total EPFR EM bond funds sample on monthly basis is USD 136bio Source: Bloomberg Major countries are keeping rates at near zero level. As a result liquidity is moving into riskier markets, including EM debt and credit bonds.

Deutsche Bank page 3 Traditional Yen carry trade High yield vs low yield currencyDemand for risky assets Source: Bloomberg Before the crisis, Yen was the lowest funding currency. High yield currencies and commodity currencies were typical targets for carry trade investors.

Deutsche Bank page 4 Weaker dollar and a stronger Yen USD/JPY rate differences are narrowingDollar index on a weakening trend Source: Bloomberg Japanese overseas investments decreased after the crisis while outflows from US have increased. That is reflected by a stronger Yen and a weaker dollar.

Deutsche Bank page 5 Quantitative Easing continuing Balance sheet of the Federal Reserve (Asset side)Balance sheet of the Federal Reserve (Liability side) Source: Federal Reserve Carry trade investments could shrink if the Fed is going to tighten. That said market expectations are that central banks will continue QE until next year.

Deutsche Bank page 6 Global inflation pressure still low Conundrum of long term UST ratesFixed exchange rate policy in China Source: Bloomberg Property prices and labor market in the US are the key factors for global demand. China is keeping an export driven policy with undervalued currency and increasing foreign exchange reserve.

Deutsche Bank page 7 Expectations for a stronger Korean won Current & Capital account surplus after the ’08 crisisKorean won vs KOSPI performances Source: Bloomberg Note: Capital account fluctuations in APR/MAY ’10 are due to one time banks’ short term debt changes Korean won is strengthening despite smoothing operations by BOK. Both current account and capital flows are supporting the Korean won value.

Deutsche Bank page 8 Accommodative monetary policy and asset prices Decoupling of equities and interest rates intensifying as plenty liquidity is provided globally

Deutsche Bank page 9 Foreigners’ inflows after the financial crisis Monthly chg in Foreingers’ bonds and equities positionsForeigners’ holding of Korean bonds Source: FSS, DB Foreigners are bullish on Korean assets. Inflows / outflows on the equity side had some impact on USD/RKW while bond flows increased gradually this year.

Deutsche Bank page 10 Foreigners moving to long term KTBs Monthly increase in Foreigners’ holdingForeigners’ position in KTB futures Source: Bloomberg, InfomaxSource: FSS, DB Foreigners bought KTBs aggressively this year while demand for MSBs were weak. Foreigners also increased their KTB futures position to historically high level in July.

Deutsche Bank page 11 Real money flows instead of arbitrage investments YTD net investment by countryCountrywise net investment of Korean bonds Source: FSS, DB Thai investors, who bought KRW 8tn in ’09, are flat in ’10. Luxembourg, US, China are the main investing countries recently.

Deutsche Bank page 12 Basis spread narrowed too much Korean basis, less attractive compared to CDSUSD funding conditions improved Source: Bloomberg Arbitrage investments from Thailand are decreasing as basis level narrowed rapidly. Local USD funding conditions improved despite FX regulation talks.

Deutsche Bank page 13 Searching for high yield bonds 10y Treasury rates vs CPI for Asian countries10y Treasury rates vs CPI for major countries Source: Bloomberg Long term real money investors are looking for bonds with 1) high yield and 2) a stable currency (low CPI)

Deutsche Bank page 14 Foreigners in the Thai local bond market Foreigners’ holdings of Thai local bondsDownward pressure exchange rate with higher equities Source: Bloomberg Notes: BOT target rate is 1.75% and 10y Treasury rate is 3.19% as of 24 Sep Foreigners are increasing their bond holdings in the Thai market after ’08. As a result the currency strengthened while interest rates fell to historically low level.

Deutsche Bank page 15 Swap spreads on a narrowing trend Swap spreads are stabilizingLong term / short term spread narrowing Source: Bloomberg All kinds of spreads are narrowing on plenty liquidity in the market. Foreigners are also moving gradually to real money instead of derivatives investments.

Deutsche Bank page 16 Overview Charts – AUD/USD

Deutsche Bank page 17 Overview Charts – KOSPI

Deutsche Bank page 18 Overview Charts – USD/KRW

Deutsche Bank page 19 Overview Charts – 3y KTB rate

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