Despite Bank of Korea Governor Lee Chang-yong’s warning, the market is betting on an interest rate cut within the year, leading to a yield inversion phenomenon in which short-term bond yields of less than one year fall below the benchmark rate (3.5%). Bond market experts predicted that the ‘reverse carry’ trend, in which the funding rate is lower than the bond rate, will continue for a long time to come.
According to the Korea Financial Investment Association on the 18th, short-term bond yields of less than one year are below the standard rate of 3.5%. The 91-day certificate of deposit (CD) interest rate closed at 3.43% the previous day. The 91-day CD has been below the base rate for five consecutive trading days since the 11th, when the Bank of Korea froze the base rate. The 91-day MSB and 1-year Treasury bonds fell below the base rate at 3.489% and 3.484%, respectively, on the 13th of last month, and have been below the base rate for about a month. This means that the profit is less than the cost of procurement.
The reason why short-term bond yields of less than one year are lower than the base rate is that the market expects the base rate to be cut within three months. Amid rising financial market unrest after the bankruptcy of Silicon Valley Bank (SVB) in the US, concerns about poor real estate PF loans and economic recession spread expectations that the Bank of Korea will not further raise the base rate and ease monetary policy within the year. that reflects this.
The fact that the yield for less than one year is below the base rate is due to supply and demand factors in addition to expectations of a rate cut.
The increase in financial arbitrage trading by foreigners is leading to a drop in short-term interest rates. After the bankruptcy of the SVB, foreign funds flowed into domestic bonds en masse from the spot and futures markets. Unlike futures, which are flowing in reflecting interest rate cuts, most of the money flowing into the spot market is demand for financial arbitrage trading. This is because short-term interest rates have fallen rapidly following the US Fed’s easing of monetary tightening concerns and interest rate cut expectations after the bankruptcy of the SVB, increasing the financial arbitrage factor for dollar holders. According to the financial market, out of the 14.8 trillion won in bonds that foreigners have purchased since March 13, when SVB went bankrupt, 8.4 trillion won is less than one year old.
The massive participation of individual investors in the bond market also led to the bullishness of bonds with a maturity of less than one year. Since last year, as stock prices have been sluggish and interest rates have risen, individual investors are participating en masse in bond investments.
Among bond ETFs, short-term funds are the most popular. Currently, 19 out of 76 bond ETFs listed in Korea are short-term fund ETFs. As of the 13th, of the balance of 26.1 trillion won in bond-type ETFs, short-term funds accounted for more than half at 14.5 trillion won.
The fact that time deposits are decreasing due to commercial banks’ cut interest rates on deposits, while money market fund (MMF) balances are increasing, which is a short-term safe asset, also had an effect. Commercial banks are cutting deposit interest rates this year, and MMF funds are steadily increasing. According to the Korea Investment Association, the average total amount of MMF net assets in the first quarter of this year was 194.7 trillion won, up from 157.8 trillion won in the previous quarter. On February 6, the total amount of MMF net assets reached a record high of 211 trillion won. We believe that the large-scale inflow into the MMF was the purchase of bonds with a maturity of less than one year.
The Bank of Korea is expressing an uncomfortable feeling about the drop in interest rates for short-term funds, which bet on a rate cut within the year. BOK Governor Lee Chang-yong warned at a press conference right after the Monetary Policy Committee froze the base rate at 3.5% on the 11th, saying that the bond market’s expectations were excessive about the ultra-short interest rate falling below the base rate.
Governor Lee said, “The Monetary Policy Committee members are not at the stage to consider an interest rate cut yet, but they believe that it is a situation where there is a great deal of uncertainty that needs to be decided after seeing whether prices have sufficiently converged to the 2% level.” With one-year yields falling, I think the market is overreacting in some way.”
He said, “We will have to judge ex post facto whether the market is right or the BOK is right, and who is more right about the economy or the flow of prices.” pointed out.
Governor Lee also said, “If you look at the difference between the US short-term interest rate or government bond rate and the base rate, the situation is worse than ours, such as more than twice that of Korea.” This kind of phenomenon seems to be a common phenomenon all over the world,” he said.
Bond market experts are concerned that the reverse carry phenomenon in the short-term bond market could continue for a long time. While inflation is slowing, concerns about a slowdown in the real estate market and economic slowdown are growing, expectations for a rate cut within the year will continue, but the possibility of a rate cut within the year is still low.
Kim Seong-soo, a researcher at Hanwha Investment & Securities, said, “Although most of the central banks in major countries, not just Korea, are professing their stance of ‘maintaining high interest rates for a long time,’ the market’s year-end cut outlook remains unchanged.” “Because of the experience and the expectation that eventually responding to the economic recession will be inevitable, the market will continue to reflect year-end cuts regardless of monetary policy and central bank stance, and the interest rate level that reflects the one cut within the year is expected to be maintained.” .
Lim Jae-kyun, a researcher at KB Securities, said, “The decline in interest rates on bonds with a maturity of one year or more, which was reflected in the interest rate cut within the year, is judged to be excessive.” said.
He said, “The Bank of Korea froze the base rate at the MPC in April, but it showed a hawkish attitude, saying that price stability was the top priority rather than the economy, and that it was premature to discuss a rate cut as inflation was high.” However, considering that electricity and gas rates and public transportation rates are scheduled to rise in the second half of the year, the rate of inflation is expected to slow down, so the rate cut is likely to be in the first quarter of next year rather than within this year.”
Yoon Yeo-sam, a researcher at Meritz Securities, said, “The majority of market participants are of the opinion that the downside risk of the growth path is high, and despite Governor Lee’s hawkish remarks from the MPC in April, the market maintains the prospect of a rate cut within the year.” With the expectation of lowering the base rate to 3.25%, if the rate is not immediately cut within the first quarter, the 3-year Treasury yield falling below 3.2% can be seen as reverse carry.”
Source: Donga
Mark Jones is a world traveler and journalist for News Rebeat. With a curious mind and a love of adventure, Mark brings a unique perspective to the latest global events and provides in-depth and thought-provoking coverage of the world at large.