A selling spree in Asian local currency bond markets this week fizzled out on Friday after major central banks launched a joint action to ease dollar funding conditions and stem the spreading eurozone debt crisis. Government bonds in Asia stabilised and currencies broadly held their ground after weakening sharply as large foreign banks and funds began taking profits to meet liquidity and redemption pressures back home.
The selling pressure was exacerbated as some dedicated Asia-focused debt funds stayed on the sidelines due to broader market volatility and the dollar's recent gains dimmed the appeal to hold these bonds. "Even though the fundamental story is intact, some of these markets are beginning to look like a crowded trade in this environment and we have moved to a neutral positioning (from overweight) on some of them," said Edward Lee Wee Kwok, regional head of rates strategy at Standard Chartered Bank.
Ten-year Indonesian bond yields are up by 65 basis points this week to a 1-1/2 month high even as foreign investors sold more than $500 billion between September 9 to 14. In Korea, which has a higher number of foreign banks, particularly European, markets saw selling in bonds and stocks in recent sessions as foreign investors offloaded investments.
A Goldman Sachs study of Korean government data found that France and Britain have cut their holdings of bonds in August even as other countries have added exposure in the same period. As some European banks began to find themselves locked out of interbank money markets, they have had to resort to raising funds through currency derivatives, borrowing via emergency central bank funding lines or even in some cases liquidating their holdings in Asian markets.
While the European Central Bank loaned out only $575 million at a dollar funding operation this week, deposits at its daily overnight facility has grown dramatically in recent weeks signalling a break down in market confidence. To address that, the European Central Bank said on Thursday it was joining other key central banks and the US Federal Reserve in a co-ordinated effort to ease dollar funding for stricken European banks.
The rising demand for funds has also led to increased market volatility and forced some hedge funds into liquidation. Goldman Sachs' plan to close its well-known Global Alpha algo hedge fund after incurring heavy losses is leading to speculation that the fund's liquidation is behind heavy selling in Asian currencies in the past two days, traders say.
Even though funding costs retreated from this week's highs, analysts remain unconvinced it can provide a long-term solution to debt problems as sentiments about a likely default by Greece grow sharply. A credit default swap index based on 25 European financials held just below a peak of 309 bps hit this week, and way higher than a peak of 210 bps peak reached at the height of the financial crisis, according to data by Markit.