Increased Appeal of Long-Term Bonds in the Bond Market

Narrowing of 3-Year to 10-Year Korean Treasury Bond Spread Continues
Despite Interest Rate Slowdown After July FOMC,
Short-Term Bond Yields Struggle to Decline

[Image source=Yonhap News]

[Asia Economy Reporter Minji Lee] The bond market is signaling an economic slowdown. The spread between short-term and long-term interest rates is narrowing as short-term rates rise and long-term rates fall. At the July FOMC (Federal Open Market Committee), which has significant influence on Korea's interest rate policy, Fed Chair Powell mentioned adjusting the pace of rate hikes, further raising market expectations for rate cuts. However, since inflation concerns have not completely disappeared, the spread contraction is expected to continue for the time being.

According to the Bond Information Center of the Korea Financial Investment Association as of the previous day, the yields on 3-year and 10-year government bonds were 3.090% and 3.121%, respectively, resulting in a yield spread of only 0.031 percentage points. At the beginning of this month, the spread between these two bonds was 0.051 percentage points, indicating a further decrease. The same trend is observed compared to a year ago. In early July last year, the yields on these bonds were 1.469% and 2.090%, with a spread of 0.0621 percentage points.

The difference between long-term and short-term interest rates is called the spread, and a narrowing spread can be interpreted as a higher likelihood of entering a recession phase. Typically, long-term rates are higher than short-term rates, but during the 2008 financial crisis, the spread between 3-year and 10-year government bonds not only narrowed but even inverted. As of December 25, 2007, the 4-year bond yield was 5.82%, while the 10-year was 5.78%. Although an inversion between short- and long-term bonds has not yet occurred in the domestic bond market, the gap is steadily shrinking, increasing concerns about economic slowdown. In the U.S., the inversion between long-term (10-year) and short-term (2-year) bonds has already reached 23.4 basis points (1bp = 0.01 percentage points).

At the July FOMC, Chair Powell, who had previously implemented a giant step (raising the benchmark rate by 75bp at once), mentioned that the pace of rate hikes would be adjusted going forward. However, market experts predict this will be insufficient to bring down short-term rates. The Fed's rate hikes are expected to continue, and since they have communicated plans to raise the benchmark rate quickly to between 3.0% and 3.5%, the inversion in the U.S. may widen further. Jemin Choi, a researcher at Korea Investment & Securities, said, “No guidance was provided for the September FOMC, so short-term rates are likely to rise while long-term rates remain flat until then. Although the possibility of a recession is denied, the risk of a technical recession is emerging, and concerns about recession will increase.”

In this situation, a strategy of buying long-term bonds whenever their yields fluctuate seems appropriate for domestic bond investment. Jaekyun Lim, a researcher at KB Securities, explained, “The yields on 10-year and 3-year bonds are expected to invert within this year. Although the possibility is low, if the Monetary Policy Committee implements a big step (raising the benchmark rate by 50bp at once) in August, concerns about recession will grow, and the long-short spread could narrow even faster.” This means that alongside inflation concerns, recession fears are expanding, potentially prolonging the decline in long-term bond yields.

Foreign investors are also increasing their purchases of long-term bonds, attracted by their price appeal. Foreigners have been buying ultra-long-term 30-year bonds, with their holdings rising from 1.2 trillion KRW at the beginning of this year to approximately 1.97 trillion KRW this month.

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