* Korean swaps get paid as funding needs go up
* Swaps in rest of Asia mimic downtrend in dollar swaps
By Vidya Ranganathan
SINGAPORE, Aug 14 (Reuters) - South Korean won interest rate swaps extended their two-day rise on Friday, due to a spurt in local fund raising and diverging from trends in other markets where investors were paring expectations of aggressive near term monetary tightening.
Swaps in Malaysia, India, Thailand have been closely correlated to those in dollar markets, which have been volatile this week and confronted with conflicting signals from stock markets, economic data and official rhetoric.
The Federal Reserve's reiteration this week of a commitment to low rates for a long time depressed swaps and brought down bond yields from highs hit after last week's better-than-expected payrolls report.
The one-year dollar IRS has fallen 20 basis points since last Friday to 0.73 percent, while also compressing the spread between 2-year swaps and Treasuries to 38.25 bps from as high as 47 last week.
Thai baht swaps have fallen 6 bps on the one-year tenor this week, while Indian rupee one-year swaps have fallen to 3.3 percent from 3.55 on Tuesday.
South Korean interest rate swaps have on the contrary risen. The one-year swap is now at 3.42 percent compared with 3.19 two days ago.
That has been accompanied by an unusual jump in the benchmark certificate of deposit (CD) rate. The 3-month CD rate which had held steady at 2.41 percent from April through July has jumped 5 bps since then.
Traders said a spate of fund-raising through CDs by entities such as Hana Bank had caused rates to rise, even though the CD rate was still lagging the jump in other front end yields in South Korea, driven by the buoyancy in economic data.
"Structurally, they are always short of funding and all the onshore banks have memories of liquidity squeeze," said Ju Wang, a strategist with UBS in Singapore.
"Now the economy has started to rebound quite sharply, outperforming some others in the region, so onshore banks are starting to secure some funding through CD papers."
Although the Bank of Korea has started withdrawing some of the dollar funding lines it had provided to its banks and has been among the first of central banks globally to explicitly state its exit strategy has begun, analysts think the market has been too aggressive in pricing in monetary tightening.
For instance, in forward rates agreements, the 3-month rate is already quoted at nearly 3 percent by the end of 6 months.
The one-year Korean government bond trades a 112 bps above the 2 percent policy rate.
"We feel like the front end interest rate swap market has over reacted to this too quickly. It went up quite sharply in past couple of days when rates are coming lower in rest of Asia," Wang said.
The banking system had plenty of cash from deposits sloshing around and loan growth has picked up but not enough to cause any kind of crunch, analysts said.
Yet, with a legacy of extremely high loan to deposit ratios and a history of liquidity issues, Korean banks have been predisposed to caution and an inclination to stock up cash when it is available.
"The incremental rise in the 3-month benchmark fixing rate is a sign that Korean local markets are increasingly fearful of BOK tightening," analysts at JPMorgan said in a note.
"Receiving the front end is fraught with volatility in a market still seeking some clarity on the BoK's policy path." (Editing by Kazunori Takada)