Volatility Rises in Government Bond Market... Government Likely to Increase Issuance of 30-Year Treasury Bonds

Increasing Long-Term Treasury Bond Issuance to Prevent 10- to 30-Year Yield Curve Inversion
Attention to Widening Short- and Long-Term Interest Rate Gap

[Asia Economy Reporter Kim Eun-byeol] As concerns over US-origin inflation caused a sharp rise in the 10-year government bond yield, leading to instability in the domestic bond market, the government is increasingly likely to raise the issuance ratio of ultra-long-term government bonds such as the 30-year bonds.

On the 24th, the closing yield of the 30-year government bond in the bond market was 2.050%, only 1.9 basis points (bp, 1bp=0.01 percentage point) higher than the 10-year government bond yield (2.031%). Considering that the spread between the 30-year and 10-year government bonds in the bond market last year fluctuated around 8 to 15bp, the yield gap has significantly narrowed. On the 18th and 19th, the 10-year yield was 1.4 to 1.5bp higher than the 30-year yield, showing an inverted yield curve. Typically, bonds with longer maturities have higher yields due to greater uncertainty, but due to inflation concerns, financial institutions and other investors massively sold 10-year government bonds in the market, causing the yield inversion. Additionally, demand for 30-year bonds surged among insurance companies aiming to meet the RBC (Risk-Based Capital) ratio ahead of the first quarter-end, which also contributed to the relatively smaller rise (price increase) in 30-year bond yields.

Accordingly, the market is placing weight on the possibility that the government will increase the issuance ratio of 30-year bonds instead of 10-year bonds in the short term. If the yields of ultra-long-term and long-term bonds become entangled, it becomes difficult for financial institutions to predict yields for investment, potentially sending negative signals to the market. Since domestic institutions such as insurance companies and pension funds consistently have strong demand for 30-year bonds, it is expected that there will be no problem absorbing the increased issuance.

Kim Yong-beom, the First Vice Minister of Strategy and Finance, also said at the macroeconomic and financial meeting the day before, "Investment sentiment in the government bond market is shrinking and volatility is expanding," adding, "We will do our utmost to stabilize the market, including flexible adjustment of government bond issuance volume." The Bank of Korea's Monetary Policy Board members also mentioned last month that the supply and demand of ultra-long-term government bonds should be managed.

With an additional supplementary budget (supplementary budget) announced to respond to the COVID-19 shock, requiring an increase in government bond issuance, increasing the issuance of ultra-long-term (30-year) government bonds has both advantages and disadvantages. Typically, long-term government bond interest costs are higher, which can increase interest burdens, and rising market interest rates in the future also pose a burden for the government. However, long-term government bond yields have the advantage of reducing refinancing risk due to their long maturities. Currently, South Korea's government bond average remaining maturity (11.31 years) is longer than that of other countries. The US issues a large amount of short-term government bonds and continuously repays debt, resulting in an average remaining maturity of 5.8 years, and Japan's is 8.15 years.

*Source: Bank of Korea

Meanwhile, the government and the Bank of Korea are also paying attention to the widening yield gap between the 10-year and 3-year bonds. Bank of Korea Governor Lee Ju-yeol said in a written Q&A with reporters on the same day that the pace of widening between long- and short-term interest rates in South Korea was fast.

He explained, "Typically, during economic recovery periods, long-term interest rates rise in anticipation of fundamental improvements, leading to a widening of the long- and short-term interest rate spread, which is a common phenomenon in major countries including the US," but added, "However, since March, the widening of the domestic long- and short-term interest rate spread has been influenced not only by economic recovery expectations but also significantly by external factors such as rising US Treasury yields and government bond supply and demand conditions, making the pace faster than expected." He noted that the spread is widening faster compared to major countries, warranting close monitoring.

The Bank of Korea conducts simple purchases of government bonds if market interest rates rise excessively or volatility increases. With the increase in government bond issuance scale for the supplementary budget this year, the Bank of Korea has already announced it may purchase more than 7 trillion won worth of government bonds. The governor said, "The scale of simple government bond purchases depends on how smoothly liquidity can be absorbed through the issuance of Monetary Stabilization Bonds, sales of repurchase agreements (RPs), and deposits in the Monetary Stabilization Account," adding, "Simple government bond purchases can be conducted without particular difficulties in terms of liquidity absorption for the time being."

He also mentioned that the issuance scale of Monetary Stabilization Bonds (MSBs) could be adjusted to respond to market volatility. He said, "If the need arises to respond to increased volatility in medium- and short-term interest rates or worsening supply-demand imbalances in the bond market, the issuance scale can be flexibly adjusted in the short term as done this time."

Monetary Stabilization Bonds are short-term securities issued by the Bank of Korea to financial institutions or the general public to regulate the money supply. When the Bank wants to reduce the money supply, it issues and sells MSBs in the open market; conversely, when money supply is needed, it repurchases or redeems MSBs before maturity to adjust the money supply.

On the 17th, the Bank of Korea reduced the bidding scale of 2-year MSBs from 2.2 trillion won to 1.1 trillion won, and on the 22nd, the 1-year bidding scale was halved from 600 billion won to 300 billion won. Reducing the issuance scale of MSBs decreases the supply of bonds in the market, causing bond prices to rise (bond yields to fall). This move is understood as a market stabilization measure in response to increased volatility in the government bond market, such as the 10-year government bond yield exceeding 2% due to the sharp rise in US Treasury yields. Given the recent high volatility in the bond market, adjusting issuance scales according to market conditions can improve investor sentiment and mitigate interest rate volatility.

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