BOK Likely to Expand KTB Purchases
The author is an analyst of NH Investment & Securities. He can be reached at sw.kang@nhqv.com. -- Ed.
As the portion of direct financing in the US financial market exceeds 90%, a negative FF rate is unlikely. We expect the Fed to continue cutting its financial market support. Given Korea’s record-high 1Q20 deficit, the BOK will likely expand its KTB purchases.
Focus of Fed’s powers shift from financial to real economy
Last week, the US Treasury announced that privately-held net marketable borrowings for 2Q20 will stand at US$2.9tn, 2.5 times the amount (US$1.2tn) recorded last year. Of note, the first 20yr TB issuance since 1986 has also burdened long-term yields.
However, supply burden is to be minimal for US TBs. By the end of this week, the Fed’s TB purchases in 2Q20 are expected to reach US$750bn, and even with pace adjustments, the Fed will likely absorb a total of US$855bn TBs this quarter. Also, the Fed can make appropriate adjustments to long-term issuances. Short-term TBs (1~5yr) make up most (42%) of the Fed’s SOMA portfolio, while long-term bonds over 10yrs only account for 22%. Should the US Treasury increase its issuance of long-term TBs, the Fed would be able to reduce its portion of short/mid-term bonds and expand its portion of long-term bonds. We expect the Fed to continue to support government financing, which in turn, should prop up the economy.
Last week, expectations for a negative FF rate emerged in the futures market. But, due to the nature of the US financial market, where the portion of direct financing accounts for over 90% of corporate financing, the effectiveness of a negative FF rate is questionable. Of note, implementing a negative FF rate could spur the outflow of MMF funds. Already in March the massive outflow of capital from prime MMFs caused an upsurge in CP yields. Thus, a negative FF rate appears implausible. Until a rebound in the real economy is confirmed, upward pressure on US TB yields should remain limited and TBs should trade within a narrow range.
Expecations increasing for larger KTB purchases by BOK
Korea’s cumulative fiscal execution for the year clocked at 31.5% as of end-March, up 2.41%p from Mar 2019. On an absolute scale, government expenditure rose W26.5tn y-y. However, national tax revenue decreased W8.4tn y-y and the integrated fiscal balance for 1Q20 recorded a deficit of W45.3tn, the largest amount since statistics began (Jun 1996).
While the country’s fiscal deficit needs to be curbed, the government is currently focused on boosting the economy. In reducing the crowding-out effects arising from the deficit, the BOK’s role will be key. On Apr 29, Congress passed a bill to provide government backing to specialized bank bonds, making them eligible for BOK purchase. We expect the BOK to purchase both KTBs and specialized bank bonds, gradually easing the supply-demand burden.