Worst-case Scenario Partly Eases
The author is an analyst of NH Investment & Securities. He can be reached at sw.kang@nhqv.com. -- Ed.
The BOK has announced plans for actively purchasing KTBs. Noting that during the 2008 financial crisis, the BOK purchased KTBs in line with the market duration of the time (3.7 years), we believe that buying will concentrate in the 10-year tenor. KTB purchases should range from W9.2tn to W14.8tn.
Liquidty and credit crisis worst-case scenario partly eases
On Thursday (local time), the US Fed announced a US$2.3tn financial stimulus package. The criteria for eligible issuer was expanded to include above BB- grade bonds that were rated at least BBB- as of Mar 22 but subsequently downgraded to speculative grades. Although not all junk bonds are eligible to inclusion, the Fed will rescue ‘fallen angels’ (IG → speculative grade) as such issuances served as a trigger for the credit crisis during the 2008 financial crisis. An aggressive response is being made in order to ease the possibilities of a credit crunch.
In addition, the Fed will directly purchase US$500bn worth of short-term notes from municipal entities. The making of such direct loans from the central bank to the government is taken from Modern Monetary Theory (MMT), which recognizes the government and central bank as being one accounting entity. Full-scale MMT has yet to be introduced, but some of the ideas under it are being implemented. Also, Fed’s CP purchases through CPFF will begin on the Mar 14. Amid the halt in redemption of Prime MMF due to MMLF (which started on Mar 1), CP purchases will likely bring down the Libor rates. Thus, there has been a partial easing in the chances of the worst-case liquidity and credit crisis scenario materializing. However, with downward revisions to US GDP growth forecasts still ongoing, US TB yields are to show a steady downtrend.
Lessons learned from 2008 financial crisis: BOK’s KTB purchases to be focused on long-term tenors
Last Thursday, the Monetary Policy Committee froze the key interest rate, but sharply lowered its economic judgment, hinting at a possible further rate cut. We also expect an additional rate cut as early as May and in July at the latest. Of note, Governor Lee unveiled an active plan to purchase KTBs in order to stabilize KTB market supply-demand conditions. Considering that the main cause behind the KTB market’s exclusion from the global bond market rally in 1Q20 was supply-demand burden, we view the BOK’s measures as being favorable for KTBs.
An analysis of the BOK’s expansion of KTB purchases over 2007~2008 shows a distribution of winning bid by maturity of 3yr 10.6%, 5yr 56%, 10yr 32.3%, and 20yr 0.8%. At the time, purchases were concentrated on the 5yr tenor. Based on the KIS KTB composite index, the annual average of duration over 2007~2008 was 3.7 years. In other words, the BOK’s KTB purchases were tailored to market duration. Current KTB market’s duration is 8.44yr, making it likely that BOK’s current purchases will concentrate on the 10yr tenor.
Based on the size of BOK’s purchases during the financial crisis, current net buying should range from KRW 9.2tn to 14.8tn. Even with a third supplementary budget, additional supply-demand burden will likely be limited. Against this backdrop, We view the present as being an opportune to load up on long-term KTBs.