Impact of Additional Interest Rate Cuts and SPV Establishment... 3-Year Treasury Bonds Hit Record Low

Bank of Korea, Monetary Policy Committee Meeting on the 28th
Growing Expectations for Additional Interest Rate Cut

[Image source=Yonhap News]

[Asia Economy Reporter Kim Eunbyeol] As expectations for a base rate cut this month grow, government bond yields have once again hit record lows. The decision by the government and the Bank of Korea to establish a special purpose vehicle (SPV) to purchase low-credit rating corporate bonds and commercial papers (CP) is also easing pressure in the bond market.

According to the Korea Financial Investment Association on the 23rd, the 3-year government bond yield fell to 0.832% intraday yesterday, showing a downward trend. The closing yield also set a new record low at 0.841%.

The continuous record lows in government bond yields reflect growing expectations for the May Monetary Policy Committee meeting scheduled for the 28th. Experts believe the Bank of Korea’s Monetary Policy Committee is highly likely to cut the base rate from 0.75% to 0.5% on the 28th. Even if the rate is not cut this month, there is a strong expectation for an additional rate cut at the July meeting.

Experts point out that considering the recent sharp decline in exports and the negative growth rate in the first quarter, which indicate a worsening economic situation compared to March, the likelihood of a rate cut is high. The Bank of Korea is also expected to release a revised economic outlook after the Monetary Policy Committee meeting. In February, the Bank lowered its growth forecast for this year from 2.3% to 2.1%. However, given the further economic deterioration due to COVID-19, some predict the growth rate will be significantly lowered to around 0%.

The expectation that the Bank of Korea will actively purchase government bonds to stabilize the market is also influencing the bond market.

On the 22nd, CP and corporate bond yields also fell slightly. The 91-day CP yield in the money market closed at 1.90%, down 1 basis point (1bp = 0.01%) from the previous day, marking seven consecutive trading days of decline.

In the bond market, the yield on AA- rated unsecured 3-year corporate bonds fell 1.2bp to 2.165%. BBB- rated 3-year bonds also dropped 0.8bp to 8.435%.

The slight stabilization in the corporate bond market is attributed to the decision by the Bank of Korea, government, and Korea Development Bank to establish a 10 trillion won scale SPV. The government and the Bank of Korea introduced this measure to support the market for lower-rated corporate bonds (A grade and below), which had been excluded from previous market stabilization measures such as the Corporate Bond Stabilization Fund.

The bonds eligible for purchase include corporate bonds rated AA to BB, and CP and short-term bonds rated A1 to A3. The maturity is limited to within three years. Companies with an interest coverage ratio below 100% for two consecutive years are excluded from the purchase target to prevent the SPV from supporting zombie companies. For speculative-grade BB corporate bonds, purchases are limited to those downgraded due to the COVID-19 shock (Fallen Angels).

Meanwhile, the Korea Development Institute (KDI), a government research institute, expressed concerns about economic contraction due to COVID-19 and urged for the base rate to be cut as quickly as possible. KDI stated, "With economic growth sharply contracting and consumer price inflation falling to around 0% due to COVID-19, aggressive monetary policy is urgently needed," and argued that "the base rate should be lowered to a level sufficiently close to 0%."

KDI also pointed out that not only a rate cut but also unconventional monetary policy tools, including government bond purchases, should be actively employed. KDI explained, "Due to the COVID-19 situation, there is a high possibility of issuing government bonds in the process of preparing supplementary budgets," and emphasized that "the Bank of Korea should absorb some of these government bonds."

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