Economic Concerns to Rise Further
The author is a fixed income strategist of Shinhan Investment Corp. He can be reached at jk.ahn@shinhan.com. -- Ed.
What happens when the base rate exceeds or nears neutral levels
The Bank of Korea (BOK) appears to have shifted gears from monetary easing to tightening, given the governor’s recent remarks and rhetoric changes in monetary policy decisions. The BOK has been in a similar situation twice before. The base rate exceeded the neutral rate of interest during the 2007-2008 period, creating conditions for monetary tightening. In a later 2011-2012 period, the base rate neared neutral levels. Economic growth slowed down during both periods, and prices started declining with a time lag. We have witnessed easing inflation and slowing economic growth in past tightening cycles.
Economic concerns to rise further, 3Y-10Y spread continues to narrow
We project the BOK to raise the base rate by 25bp in August. The central bank needs to continue to rein in inflation as concerns are rising that prices of domestic agricultural, livestock, and fisheries products may become volatile again ahead of the Chuseok holiday in September. Another rate hike should enhance the effects of tightening, which also means that the BOK is likely to revise down its economic growth outlook for 2022 and 2023. If the revised growth forecast for 2023 nears 2%, it will be perceived as a sign that the rate hike cycle is past its peak and raise expectations for it to finish at the end of 2022. Since economic slowdown is the reasoning behind such expectations, the upside for long-term yields is projected to weaken further.
For August, we suggest a yield band of 3.00-3.35% for 3Y KTBs and 3.05-3.35% for 10Y KTBs, with the 3Y-10Y yield spread in the 2-10bp range. The August rate hike has been reflected to a considerable extent. Growing concerns over economic recession at home and abroad have raised the possibility of a downgrade of growth outlook for 2022 and 2023. Despite possible additional rate increases, the yields on major bonds are forecast to stabilize at lower levels. Long-term bonds are expected to be relatively strong, while short-term bonds should remain weak with additional hikes carried out amid growing fears over an economic slowdown. We recommend taking a buying approach to long-term bonds if yields rebound within this month.