Sharp Drop in Government Bond Yields Due to Korean-Style Quantitative Easing... Credit Market Instability Persists

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[Asia Economy Reporter Eunmo Koo] The Bank of Korea's decision to supply unlimited liquidity to meet all market demands is expected to significantly ease liquidity pressures in the market. However, as the short-term funding market remains tight, there are calls for further consideration of more proactive measures such as the Bank of Korea's corporate bond purchases.

According to the Korea Financial Investment Association on the 27th, the 3-year government bond yield closed at 1.067%, down 6.4 basis points (1bp=0.01%) from the previous trading day. The 1-year bond ended at 0.995%, down 1.8bp, the 5-year bond plunged 12.3bp to 1.285%, and the 10-year bond fell 14.5bp to 1.502%. The 20-year and 30-year bonds also dropped 15bp and 14.3bp respectively, closing at 1.599% and 1.589%.

However, commercial paper (CP) and corporate bond yields rose. The 91-day CP yield increased by 17bp to 2.040%, marking the highest level in about five years since March 11, 2015 (2.13%). The 3-year AA- rated unsecured corporate bond yield also rose by 1bp to 2.035%. Consequently, the spread between the 3-year government bond and corporate bond widened to 96.8bp, the largest gap in approximately nine years and three months since December 10, 2010 (97bp).

On the 26th, the Bank of Korea's Monetary Policy Committee decided to purchase repurchase agreements (RPs) without limit once a week from next month through June. The bid rate will be announced each time with a ceiling set at 0.85%, which is 0.1 percentage points above the base rate (annual 0.75%). Additionally, to support large-scale liquidity supply, the scope of institutions and securities eligible for RP transactions will be expanded. This unlimited liquidity supply policy is unprecedented and was not implemented even during the 1997 foreign exchange crisis or the 2008 financial crisis.

The Bank of Korea's unlimited RP purchase decision is expected to significantly ease liquidity pressures on financial institutions. Recently, the domestic financial market has experienced financial instability with simultaneous declines in stock prices, bond prices, and the Korean won's value, raising concerns about liquidity shortages in April. In this context, the Bank of Korea's commitment to supplying liquidity backed by bonds until the end can be seen as a policy implementation comparable to quantitative easing for Korea, which is not a key currency country.

Besides alleviating short-term liquidity contraction, this move is also expected to help stabilize overall market interest rates. Yoon Yeosam, a researcher at Meritz Securities, said, "Unlimited RP purchases can partially relieve the increasing funding burden of policy financial institutions during the government's financial stability package process. Even if issuance of industrial finance bonds or some public corporation bonds increases, these can be entrusted to the Bank of Korea as RPs to secure liquidity, which will greatly contribute to market stability."

However, concerns about funding tightness remain, as seen in the rising CP yields. CP yields continued to rise even after the Bank of Korea's announcement, as the implementation timing starts from April, thus not helping to ease liquidity at the end of March. Kim Eun-gi, a researcher at Samsung Securities, said, "At the end of the quarter, there is a large outflow of short-term funds, making funding support crucial. Despite recent support measures such as the 5 trillion won liquidity support for securities firms, it still seems insufficient compared to the scale of short-term funds." Whether this short-term funding market tightness will escalate into actual credit risk will need to be monitored in early next month as the short-term funding market conditions improve or not.

Therefore, to stabilize interest rates and ease funding tightness concerns, more active discussions on measures such as the Bank of Korea's corporate bond purchases are necessary. A financial investment industry official said, "In the current situation, it is difficult to lend money for unsecured transactions like CP regardless of how high the interest rates are. Assuming legal issues are resolved, measures such as the Bank of Korea purchasing corporate bonds are needed." Currently, the Bank of Korea is prohibited from directly purchasing corporate bonds or CPs issued by the private sector under Article 79 of the Bank of Korea Act, but such purchases would be possible if government guarantees are provided.

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