Fixed income strategy
The author is an analyst of Shinhan Securities. He can be reached at jk.ahn@shinhan.com -- Ed.
Continuing tightening cycle and rising burden of short-term yield levels The Bank of Korea (BOK) is likely to maintain its tightening stance, given that March consumer prices are up 4% YoY at a lower rate but still far above the 2% target, and service prices are declining at a slow pace. The contribution of service prices to the Consumer Price Index (CPI) growth stood at 2.01%p in March, extending the 2%p-level contribution since June last year. Meanwhile, domestic banks eased their lending attitude toward businesses and households in 1Q23. Lending to businesses, which had tightened in 3Q22-4Q22, began to be relaxed in 1Q23. Contrary to US banks, domestic commercial banks seek to increase lending to businesses and households.
Private consumption also showed signs of an upturn in March after remaining sluggish in February. Domestic credit card transactions increased 9% YoY in value, exceeding the 8%-level growth seen in January and February. Based on data released by Statistics Korea, there was a 0.17 change in credit card transactions in the first week of April, indicating a 17% increase vs. January 2020 before the pandemic. The slow decline in service prices, decent domestic financial conditions, and limited downside in private consumption all provide grounds for the BOK to continue its tightening cycle. As the BOK governor stated at a recent monetary policy meeting, the yield on 91-day monetary stabilization bonds (MSB) falling below the base rate by more than 20bp can be seen as an excessive drop in short-term yields.
Moreover, there are growing concerns that foreign investors’ net buying of domestic bonds, which has centered on short-term KTBs and MSBs, may shrink to some extent. The gap between the 3M swap rate and the interest rate differential turned positive in February and climbed to a monthly average of 47bp in March. Foreign investors were able to benefit much from buying KRW-denominated short-term bonds, even more so with short- term forex translation gains. The arbitrage opportunity diminished in April, as the gap fell below 10bp recently because of a sharp increase in the interest rate differential. The yield on 3M MSBs accelerated its decline since mid-March, while the 3M LIBOR rate remained on a steady uptrend. This may put upward pressure on short-term yields.
Buying opportunity in upturn in yields led by short-term bonds
The YTD cumulative net buy in KTBs and MSBs with maturity of less than a year amounts to KRW2.3tr for foreign investors, KRW6.6tr for investment trusts, and KRW9.1tr for banks. Foreign investors were net sellers in January, but turned to net buyers with focus on short-term bonds from February following the rise in arbitrage opportunity. They could reduce their net buying in April compared to the two previous months on weakening arbitrage opportunity. Together with the BOK’s tightening stance, a decline in foreigners’ net buy will increase the burden of current short-term yields. However, we see ample short-term liquidity in domestic financial conditions. MMF balance has increased by over KRW30tr from end-2022 and remains on the KRW180tr level. The net buying trend in short-term bonds may continue, led by investment funds. And banks appear to aggressively engage in buying activity. Various investors are poised to buy short-term bonds upon an upturn in yields. We continue to believe higher yields will create a buying opportunity.