Why Treasury Yields Rebounded Despite US-Iran Tensions

Lower Expectations for Base Rate Cut Limit Bond Yield Decline
Domestic Economic Rebound Hopes Also Play a Role

Recent 10 Trading Days Treasury Bond Yield Trends (Source: Korea Financial Investment Association)

[Asia Economy Reporter Eunmo Koo] Although preferences for safe assets have strengthened following heightened tensions between the United States and Iran, government bond yields have instead risen. This is analyzed to be due to diminished expectations for a base interest rate cut, which is also limiting the decline in bond yields.

According to the Korea Financial Investment Association on the 9th, the 3-year government bond yield closed at 1.363%, up 3.2 basis points (bp, 1bp=0.01%) from the previous day. The 5-year government bond yield rose 4bp to 1.460%, and the 10-year yield increased by 1.7bp to 1.630%. Meanwhile, long-term bonds such as the 30-year fell 0.9bp to 1.615%, and the 50-year dropped 0.8bp to 1.614% at the close.

As geopolitical uncertainties in the Middle East expanded and domestic and international stock markets weakened, prices of safe assets like government bonds also declined (yields rose). This is somewhat contrary to the typical bond market behavior where prices rise (yields fall) amid increased market instability. Last week, as tensions between the U.S. and Iran escalated, investment demand for bonds expanded, and the 3-year government bond yield sharply dropped 5.7bp to 1.270% on the 3rd. However, since the 6th, yields have reversed and risen for three consecutive days, indicating a mitigation of Middle East risk.

The reason bond yields are strong even amid heightened safe asset preference is due to lowered expectations for a base interest rate cut. The general market outlook is that the domestic base rate will either be maintained for the time being or, if cut, will only be reduced once. With the floor for interest rate declines set by the base rate, bond yields have not been able to sustain a significant downward trend (bond price strength) despite a market environment favoring safe assets.

Researcher Yonggu Cho of ShinYoung Securities stated, "While the U.S.-Iran conflict is a short-term positive factor for bond prices, unless the conflict escalates to an extreme, it is not an issue that can change the monetary policy stance." He added, "Considering the base rate of 1.00%, the room for market rate declines appears to be around 15bp, and given the considerable uncertainty, reaching that level quickly is difficult." Researcher Saem Lee of Hana Financial Investment also commented, "Because there is a perception of a rate floor, volatility is inevitably limited."

Expectations for a domestic economic rebound are also limiting bond strength. Researcher Jeongin Heo of KTB Investment & Securities explained, "As the leading economic index stabilizes at its bottom and rebounds, expectations for economic recovery are growing. Since these expectations are already reflected in bond yields, government bond yields are rising even when there is much positive news for bonds in the market." According to the Organisation for Economic Co-operation and Development (OECD), Korea's leading economic index in October last year was 98.88, up 0.03 points from the previous month, marking a rebound for the first time in two years and five months since June 2017.

Bond yields are expected to remain largely within the current range for the time being. Researcher Lee predicted, "Unless a base rate cut occurs in the short term, yields will move within the current range for the time being." For the 3-year government bond yield, Lee suggested a range of 1.25?1.40%, while Heo proposed 1.25?1.35%.

This content was produced with the assistance of AI translation services.