The Great Unwinding Inches Closer to Reality... in South Korea

The South Korean’s are poised to begin dumping Treasuries. The reasons: yields are too low after 300 basis-points of Federal Reserve rate cuts since last fall; and the volatile greenback is giving investors' fits.

My colleagues Jack Crooks and Sean Hyman have long pointed out the fact that an uncomfortably large share of U.S. government bonds reside in portfolios of global central banks and other international funds.

The danger is a “great unwinding” of these holdings in which investors, fed up with the sinking dollar and U.S. policy, decide to “strategically reallocate” these assets to more compelling investment opportunities elsewhere.

In other words: foreigners begin dumping Treasuries in mass – sending the dollar into free-fall – and U.S. interest rates soaring. This doomsday scenario inched a bit closer toward reality this week, as South Korea announced just such a “reallocation” out of Treasuries.

South Korea’s National Pension Service (NPS) with $220bn in assets is the world’s fifth-biggest pension fund. This week the NPS said it “will no longer buy US Treasuries because yields are too low. The move signals what could be a big shift by financial institutions away from US government debt into higher-yielding assets”, according to a story in the Financial Times.

One of the fund’s investment managers said: “It is difficult to buy more US Treasuries because the portion of our Treasury investment is already too big and Treasury yields have fallen a lot.” Indeed the yield on 2-year Treasury Notes has tumbled from about 5% last summer, to yield less than 2% now.

Another fund manager with the South Korea’s NPS explains (emphasis mine): “The Fed continues to cut interest rates. We are still making profits from the Treasuries that we bought in the past but we think we’d better dispose of them and had better buy higher-yielding European-government debt.”

Last week, Asian central bankers at a conference in Indonesia said they might invest more of their one-trillion dollars of official reserves “in one another’s sovereign bonds instead of US Treasuries, given the dollar’s volatility”.

Could this be the beginning of the great unwinding? Stay tuned...