Fixed Income Strategy: Concerns Stronger for an Extra Budget Than a Rate Hike

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The author is a fixed income strategist of Shinhan Investment Corp. He can be reached at jk.ahn@shinhan.com. — Ed.

 

Supplementary budget concerns could spark an upturn in long-term KTB yields

The Korean government is likely to keep current social distancing rules in place amid the continuing spread of COVID-19. Lowering social distancing levels seems risky given the typical increase in gatherings during end-of-year and new year holidays (including the Lunar New Year holiday at end-January). We believe prolonged social distancing will further dampen consumer sentiment and negatively affect private consumption growth through 1Q22. Given that consumer indicators could worsen towards February as a result, the central bank’s Monetary Policy Board (MPB) should find it relatively easier to raise the base rate to 1.25% at its January meeting instead of later in the year.

Regardless of the outcome of the upcoming presidential election, a supplementary spending plan that includes loss compensation for small-sized businesses will likely emerge as a key topic in discussions of additional measures to cope with the prolonged impact of COVID-19. With further stimulus efforts to require a relatively bigger extra budget, market concerns for a possible issuance of deficit-covering KTBs could drive up long-term KTB yields going forward.

Base rate hike reflected in bond yields; short-term yields to stay relatively stable

Expectations for a base rate hike to 1.25% have already been reflected in bond yields. Even if an actual rate hike occurs in January, its impact on the bond market should be limited as a result. Meanwhile, we expect to see rising concerns for an increase in KTB issuance amid growing talks of a supplementary budget from January. Investors need to be cautious of a possible upturn in long-term KTB yields towards the end of January.

For January 2022, we suggest a yield band of 1.70-1.85% for 3Y KTBs and 2.10-2.30% for 10Y KTBs. The 3Y-10Y yield spread should move within 40-45bp. With the Bank of Korea projected to adjust the pace of monetary policy normalization around the JanuaryMPB meeting, short-term KTB yields are likely to stabilize at lower levels. In contrast, long-term KTB yields are forecast to turn upward near the end of January on concerns over an increase in KTB issuance to fund a supplementary budget. We thus recommend focusing on the relatively stable yields of short-term KTBs in January.


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