The Daily Update - Korea upgrade and falling yields

Standard and Poor’s upgraded South Korea’s long-term credit rating by one notch to AA on Monday citing “Korea’s strong record of steady growth has generated a prosperous economy”. The rating agency went on to praise the country’s well diversified economy and “superior” GDP growth spurred by investment on construction and private spending. Despite the upgrade taking the country’s rating in-line with Moody's the market reacted very positively to the news and yields on the benchmark bonds fell between 5-10bps.

Standard and Poor’s went on to upgrade ratings for some commercial and policy banks, and quasi-sovereigns in South Korea reflecting their systemic importance thus the “high” likelihood of government support or “additional government support notching”. The likes of state-owned Korea Gas 2.25% 2026 (issued in July) has seen yields fall to as low as 2.23% and according to our Relative Value Model, the  Aa2/AA- bond is trading at fair value with no credit notch protection.

South Korean bonds have been previous favourites of ours but are relatively overvalued for our liking. We prefer to hold the likes of Qatar’s international telecommunications company, Qtel 3.75% 2026 (Aa3) which offers an expected return around 6.5%, yield of 3.3% and 3 notch uplift. Also, regular readers will recall a daily note which mentioned our position in Abu Dhabi state-owned Taqa National Energy 4.375% 2026. This bond has been one of the better performers since it was issued in June, having rallied 8.75 points we have been reducing our position as it nears fair value. The Aa2 rated bond still offers returns in excess of any similar Korean bond, in fact if the bond was to trade at the same level as the Korea Gas 2026 issue our models calculate that the bond could see a capital gain of over 11 points!

Keeping with falling yields, Spanish 10-year bonds yesterday saw yields fall below 1% for the first time on record. The ECB’s asset-buying programme and loose monetary policy globally are no doubt giving a helping hand to such bonds which most wouldn’t have touched with a bargepole; especially as political instability continues to plague the country. Interestingly, the only 10-year benchmark eurozone bonds which trade above 1% are: Portugal, Italy, Greece and Cyprus, not quite your PIGS, but close enough!