Credit Market Frozen Amid Interest Rate Freeze

Credit Spread Approaching Three Digits
Uncertainty in Monetary Policy Expands in Second Half
Institutions Sorting Wheat from Chaff Amid Investor Sentiment Contraction

[Asia Economy Reporter Minji Lee] Although government bond yields are on a downward trend, the corporate bond issuance environment is deteriorating further. The "credit spread," which can gauge the bond issuance environment, has surged from 45bp (1bp=0.01%p) at the beginning of this year to nearly 100bp currently. Since market participants' attention is focused on interest rates, it seems difficult for the corporate bond market to regain vitality unless uncertainties are completely resolved.

According to the bond industry on the 3rd, the credit spread (the difference between the 3-year corporate bond yield with a credit rating of 'AA-' and the 3-year government bond yield) stood at 99bp as of the previous day. A larger credit spread indicates a harsher bond issuance environment. With absolute interest rates rising, the yield on 3-year AA- corporate bonds is 4%, while the 3-year government bond yield is 3.01%.

This is the first time since the 2008 financial crisis that the credit spread is approaching triple digits. Although it is unlikely to reach the level of November 2008 (over 300bp), when the financial crisis intensified, it is clear that the bond issuance environment has worsened. Last month, the government announced the operation of a 'Corporate Bond and CP Purchase Program' to facilitate smooth funding for companies and expanded the purchase scale to 6 trillion won, but the effect was minimal.

The biggest reason the issuance market has frozen is that institutions find bonds issued by companies unattractive. For investors, bond yields are the most important factor, but with the direction of monetary policy in the second half of the year unclear, investment sentiment has weakened. While there was oversupply earlier this year as many companies issued corporate bonds before interest rate hikes to secure cash, now, despite reduced supply, demand has sharply declined, causing the issuance market to not function smoothly.

Institutions also lack sufficient funding capacity. Eun-ki Kim, a researcher at Samsung Securities, said, "Net purchases of corporate bonds are decreasing mainly among asset managers whose operational capacity weakened due to fund redemptions at the end of the first half," adding, "Compared to last year, major institutions' net purchases of corporate bonds remain low."

As concerns over an economic recession grow, investors buying corporate bonds are becoming more selective. A representative from an asset management company explained, "After experiencing a sharp interest rate hike last month, the yield on asset-backed securities (ABS) has become prominent, leading to large-scale absorption by securities trust accounts and pension funds this month," and added, "In the secondary market, trading is active mainly in ultra-short-term (1-2 years) bonds issued by credit card companies affiliated with commercial banks, which have low liquidity concerns."

Bond experts expect the credit market recovery to occur around the fourth quarter of this year or the first quarter of next year, as monetary policy uncertainties remain unresolved. In the short term, interest rate uncertainties may decrease depending on the Bank of Korea's Monetary Policy Committee's rate hike this month and the U.S. Federal Open Market Committee (FOMC) rate decision in September. If the spread narrows somewhat, recovery is expected to begin with higher credit ratings that have solid credit spreads. Jun-yong Kim, a researcher at NH Investment & Securities, advised, "It is better to continue investing mainly in higher-rated bonds that offer attractive maturity yields and have low risks of fundamental deterioration and credit events even during a recession," and recommended, "Since there is still issuance pressure on public and bank bonds, it is advisable to focus on corporate bonds and asset-backed securities."

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