"Deepening Synchronization of US Treasury and Major Countries' Bond Yields... Increased Volatility Potential↑"

The Bank of Korea Analyzes Background of Treasury Bond Yields Surpassing Year-Round High on Blog

[Image source=Yonhap News]

[Asia Economy Reporter Seo So-jeong] As government bond yields hit their highest levels of the year again on the 1st of this month, an analysis has emerged suggesting that it will be difficult for interest rate volatility to decrease due to ongoing uncertainties in domestic and international economic conditions and challenges in interest rate forecasts.

The Bank of Korea recently posted a blog titled "Rebreaking the Yearly High of Government Bond Yields: Background and Evaluation," highlighting this point.

The yields on 3-year and 10-year government bonds reached 3.78% and 3.81%, respectively, on the 1st, marking the highest levels since August 2011 and May 2012. Government bond yields had been rising rapidly since August last year when the Bank of Korea normalized its accommodative monetary policy following COVID-19 and responded to high inflation. However, since mid-June, yields gave back some of their gains and stabilized near 3.0%. Yet, after August, both 3-year and 10-year yields rebounded sharply by more than 0.6 percentage points (60 basis points).

The Bank of Korea attributed this rise primarily to a weakening expectation that the U.S. Federal Reserve's monetary tightening would ease. Since mid-June, the international financial market saw growing downside risks to the economy, such as two consecutive quarters of negative U.S. economic growth, which quickly fueled expectations that the Fed would slow the pace of rate hikes. However, at the end of August, Fed Chair Jerome Powell emphasized at the Jackson Hole Economic Symposium the need to maintain a tightening stance until there is confidence that inflation has eased, which drove yields higher.

Additionally, the Bank of Korea's economic outlook, which exceeded market consensus, contributed to the rise in yields after August. Through its August revised economic forecast, the Bank projected growth rates of 2.6% and 2.1% for this year and next year, respectively, exceeding potential growth rates, driven mainly by private consumption. This positive assessment of the domestic economy acted as a factor pushing yields up by limiting expectations of rate declines due to economic slowdown and constraining investment demand.

Moreover, the concentration of government bond futures trading led by foreigners, who adjust their expectations of market interest rates based on directional forecasts, intensified upward pressure on government bond yields. Since mid-June, foreigners rapidly built long positions in government bond futures expecting rate declines but began net selling futures after mid-August in response to changes in global monetary policy expectations, quickly unwinding their previously established long positions. Notably, in the four trading days following the Jackson Hole meeting at the end of August, foreigners sold over 30,000 contracts of 3-year government bond futures, coinciding with a 25 basis point surge in the 3-year government bond yield during the same period.

Meanwhile, examining the impact of foreigners' net buying (net selling) of government bond futures on government bond yield declines (rises) through the correlation coefficient between the two variables shows that from January to May this year, the coefficient remained around 0.08, but it expanded to approximately 0.63 after June.

The Bank of Korea stated, "In the domestic market, the tendency for interest rate synchronization with major countries is very pronounced, and the year-to-date increase is somewhat lower compared to major countries." It added, "Even when comparing only the period after the rapid rise in domestic government bond yields in August, the increase in both short- and long-term yields is not larger than that of major countries." Given that domestic yields fell relatively sharply in July, the rise in yields after August can also be understood as an interest rate adjustment occurring in the process of synchronization with major countries.

However, the Bank of Korea forecast that interest rate volatility could expand due to ongoing uncertainties in domestic and international economic conditions and the resulting difficulties in interest rate forecasts. The Bank said, "With the synchronization of U.S. Treasury yields and major countries' government bond yields intensifying, volatility in U.S. Treasury yields due to changes in Fed policy stance will continue to affect not only major countries but also the volatility of our country's government bond yields." It added, "Policy authorities must continue efforts to maintain market stability through smooth communication with financial markets to prevent excessive interest rate volatility from hindering smooth funding and management by economic agents."

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