Net investment rises when inflation is stable, but retreats during price surges

High inflation turns rising long-term yields into a warning sign, not a buying opportunity

Bank of Korea warns fiscal concerns may further limit investment expansion

Federal Reserve Chair Kevin Warsh answers reporters' questions after an FOMC meeting at the New York Fed headquarters on Wednesday (local time). [AP]
Federal Reserve Chair Kevin Warsh answers reporters' questions after an FOMC meeting at the New York Fed headquarters on Wednesday (local time). [AP]

The Bank of Korea said Thursday that despite US 10-year Treasury yields surging to their highest level in 24 years, Korean investors are unlikely to significantly expand their overseas bond holdings. When US inflation pressures are elevated, the risk of valuation losses grows as yields may rise further — dulling the appeal of high rates, the central bank said.

Bond prices fall when yields rise, meaning investors who hold existing bonds stand to lose if rates climb further.

The Bank of Korea's International Department overseas investment analysis team laid out the findings in a report released Thursday titled "Characteristics and Implications of Resident Overseas Bond Investment During Periods of Rising and High US Interest Rates."

According to the report, the US 10-year Treasury yield climbed to 5.3 percent on Oct. 5, the highest since April 2002, when it reached 5.34 percent. Against that backdrop, Korean residents' overseas bond investment — which had broadly shown net outflows in the first half of this year — swung to net inflows in July and August. Net investment means purchases exceeded sales or redemptions; net outflows are the reverse.

The report analyzed four periods since 2015 in which US Treasury yields rose or stayed elevated, dividing them into "stable" and "expansionary" phases based on what it called "inflation momentum" — defined as the average US consumer price inflation rate over the preceding three months, a gauge of whether price pressures are building.

The analysis found that overseas bond investment increased during periods of stable inflation momentum and contracted when momentum was expanding.

During the July 2016–October 2018 period of gradual rate hikes amid economic expansion, the 10-year yield rose 152 basis points (1 basis point = 0.01 percentage point) while residents' net overseas bond investment averaged $2.61 billion per month. During the April 2023–December 2025 period — when high rates persisted amid solid growth and fiscal concerns even as inflation momentum eased — yields rose 47 basis points and net investment averaged $1.18 billion per month.

By contrast, during the July 2020–October 2022 period, when post-pandemic inflation surged and aggressive monetary tightening pushed yields up 324 basis points, net outflows averaged $20 million per month. Net investment from February through August of this year — a period of energy-driven inflation and ongoing fiscal concerns — was also limited to an average of $20 million per month.

The Bank of Korea's regression analysis further confirmed that stronger inflation momentum tends to reduce residents' net overseas bond investment. "The decline in resident overseas bond investment during the second quarter of this year may have been partly attributable to expanding inflation momentum," the bank said.

However, the interaction between the level of Treasury yields and inflation was not clearly defined. The Bank of Korea then broke down US long-term yields into expected short-term rates and term premiums for a separate analysis, finding that when inflation pressures are high, a rise in the term premium does less to boost net overseas bond investment. The difference was not statistically significant for expected short-term rates.

The expected short-term rate reflects market expectations for how short-term rates will move going forward, while the term premium is the additional return investors demand for holding a bond over a longer period and bearing the risk of interest rate fluctuations.

Even when the term premium rises by the same amount, investors treat it as greater compensation when inflation is stable, but as greater uncertainty when inflation is unsettled. "This suggests that when inflation pressures are high, the risk of losses from future rate uncertainty may loom larger than the expanded risk compensation or bargain-buying incentive that comes with a rising term premium," the report said. Conversely, when inflation pressures are low or easing, a rise in long-term yields may be seen as a buying opportunity, potentially boosting investment demand.

"US inflation pressures remain elevated and fiscal concerns persist, meaning the perceived risk of losses from bond investment may be relatively high," the Bank of Korea said. "Even if high yield levels raise the incentive to invest, inflation uncertainty could limit any expansion in investment."


kimstar@heraldcorp.com