South Korean treasury bond yields, which had been rebounding since hitting their lowest level of the year on August 16, turned downward on Tuesday due to the adverse economic outlook.
According to the Korea Financial Investment Association, yields of three-year Koren treasury bonds closed at 1.228%, down 0.5bp from the previous day. Yields of five-year and 10-year treasuries closed at 1.290% and 1.331%, down 0.7bp and 1.3bp respectively.
The Korean government bond market had been experiencing a correction as investors’ appetite for profit-taking grew high. The Bank of Korea’s monetary policy stance, which failed to meet market expectations, and a planned surge in the issuance of treasury bonds next year also affected the profit-taking appetite. Interest rates on long-term government bonds with maturities of five years or longer had risen more than 10bp from the year low, steepening the yield curve.
The South Korean government proposed a record-breaking budget of 513.5 trillion won (US$423.7 billion) for next year, hoping thereby to cope with an economic downturn stemming from the prolonged US-China trade dispute and to deal with Japan’s tightened export controls on critical parts and materials.
The Korean Finance Ministry expects total government revenue, including tax, to increase only 1.2% to 482 trillion won next year, leaving quite a big gap with spending.
The government proposes to sell a record-breaking 60.2 trillion won worth of deficit-covering treasury bonds, which almost doubles this year’s 33.8 trillion won. With surging deficit-financing bonds, the total issuance of treasury bonds is proposed to increase to 130.6 trillion next year, up 26.04 trillion won from this year’s plan. The budget and treasury bond issuance plan has yet to pass the approval of the National Assembly.
Experts said that the increase in treasury bond would put a considerable burden on the bond market and cause volatility.
Shin Dong-soo, a fixed-income strategist at Eugene Investment & Securities, said in a report published on Tuesday, “The bond yield has rebounded, but it is still low (bond prices are high). The low level of yields has made bond investment less attractive with expectations of capital gains weakened.”
“The sharp increase in the issuance of treasury bonds next year has also raised concern about the supply and demand condition,” he said. “With the burden on the low-interest rate levels remaining, the increase of bond supply will weaken the bond price and raise the volatility in the market. ”
However, expectations for the downward trend of bond yields still continue due to the global economic slowdown and uncertainties stemming from the protracted US-China trade dispute and Brexit, followed by monetary policy easing by major economies.
South Korean economic fundamentals also support the trend. Following a 13.6% drop in exports in August, Korea’s GDP growth rate for the second quarter was revised down 0.1%p to 1.0%, and consumer prices fell 0.04% on-year in August.
Regarding the slight drop in consumer prices, the government and the central bank dismissed the possibility of deflation, saying that supply-side played a significant role in slightly falling consumer prices. They singled out a fall in agricultural, livestock and fisheries prices and a fall in international oil prices as significant factors. Core prices, excluding food and energy prices, rose 0.8% in August.
An official of the Bank of Korea acknowledged in a telephone conversation with Asia Times that inflationary pressure from the demand side is not high due to the sluggish economic growth. But, he said, “When we monitor the underlying trend of consumer prices excluding one-off factors, now is not the time to worry about deflation.”
Even if worries on the deflation are overdone, consumer prices in August must have raised expectations for a further rate cut by the central bank.
“There are still high expectations for further policy rate cuts and uncertainties stemming from trade disputes and Brexit,” said Shin Dong-soo of Eugene. “The downside risk in the Korean economy is also growing, and it seems difficult for Korea to achieve this year’s growth estimate of 2.2%.”
He thus said, “While the largest-ever issuance of treasury bonds is expected to constrain the fall in bond yields, it will not change the downward trend of interest rates.”
However, he predicted, “If events showing the progress of the US-China trade dispute and Brexit take place, that could reduce demand for bonds and worsen volatility in the market with increasing sales of government bonds.”
Another bond market expert said, “The government should make the right plan and strategy to issue treasury bonds to soothe market woes regarding the supply issue, including the proper allocation of maturities while keeping a close eye on market conditions.”
The Korean Finance Ministry has continued to increase the supply of long-term bonds.
It also keeps a policy stance of issuing treasury bonds evenly every month. If the trend continues, the average monthly sales of treasury bonds will increase by 2.4 trillion won every month to a hefty 10.9 trillion won from 8.5 trillion won this year.
A Finance Ministry official told Asia Times, “Basically, there will be no problem in selling the planned volume of government bonds because the local primary market is healthy with the bidding rate reaching 200-300% in every treasury bond auction.”
“So far, we have always issued treasury bonds in consultation with the market,” he said. “We will minimize the impact of the increasing bond issuance on the market by closely monitoring the supply and demand situation through consultations in the future. ”
Besides government bonds, Korea Housing Finance Corp’s plan to issue mortgage-backed securities (MBS) worth multiple trillions of won adds another supply-side problem to the market. The government-run financial firm will sell a housing loan with a low fixed interest rate this month and plan to issue MBS securitizing this loan as an underlying asset.