Fiscal Expansion Key
The author is an analyst of NH Investment & Securities. He can be reached at sw.kang@nhqv.com. -- Ed.
Last week, the US TB 30yr-10yr spread and the copper/gold ratio both rose, suggesting that expansionary fiscal expectations and rising inflation expectations are behind the recent rise in US TB yields. On the domestic front, the decision by MOEF to make 2yr KTB issuances routine is encouraging, but it is unlikely to eliminate the supply burden.
Post-election: Inflation expectations to rise on aggressive fiscal policy
Although uncertainty is high with a week left to go until the US presidential election, we believe that under-the-surface changes in the financial market are more important than the election outcome. US TB yields will face upward pressure through yearend no matter which candidate wins. Of note: 1) concerns over a consumer spending cliff due to the depletion of federal unemployment benefits in October are rising; and 2) the Treasury’s cash accumulation is at an all-time high of US$1.7tn. We view that additional economic stimulus is only a matter of time.
Last week, US 10yr TB yield increased to 0.84% on additional stimulus hopes, rising past the post-March trading range. Of note, the US TB 30yr-10yr spread recovered to its previous high of 80bp and the copper/gold ratio, a proxy for inflation expectations, also rose to its previous high of 3.6x. This suggests that expansionary fiscal expectations, a key theme of 4Q20, are behind the uptick in TB yields and inflation expectations. 10yr BEI, which had turned downwards due to doubts over the Fed’s method of stimulating inflation after the Jackson Hole meeting, also returned to 1.75%p. With the Fed relying on Modern Monetary Theory, we judge that US TB yields will face upward pressure till yearend.
2yr issuance: Encouraging but not enough
The Ministry of Economy and Finance (MOEF) announced its plan to issue 2yr KTBs on a regular basis starting from 2021. On the day of the announcement, long-term yields plunged on expectations that long-term (over 10yr) issuances will fall. In other words, Operation Twist is taking place on the issuance side.
Current issuance targets by maturity band are 40±5% for 3~5yr, 25±5% for 10yr, and 35±5% for 20~50yr. Actual share issuance thus far in 2020 is 19.7% for 3yr, 20% for 5yr, 26% for 10yr, and 34% for ultra-long term. MOEF said during its press release last Tuesday that it is likely to cut the portion of ultra-long-term bonds to 30% and expand the portion of 3~5yr KTBs to 45%. In this case, the issuance of 10yr+ KTBs will decline by W8.65tn, which amounts to only 8.6% ultra-long KTB issuance (based on total issuance of W172.9tn in 2021). Noting 10yr+ KTB issuance has increased 64.5% y-y in 2020, MOEF’s new plan is not enough to eliminate the supply burden. We believe there is no need to rush to buy long-term KTBs, and we maintain our defensive strategy of investing in short-term KTBs.