Reducing National Debt and Injecting Money into the Market... Can Credit Sentiment Improve?

Credit Spread Surges to 135bp
Government's 50 Trillion Large-Scale Liquidity Support and Reduction in Treasury Supply

[Image source=Yonhap News]

[Asia Economy Reporter Minji Lee] As the government has announced a drastic measure to reduce the issuance of government bonds while supplying liquidity to the market, attention is focused on whether the credit market can stabilize. Experts expect interest rate stabilization and supply-demand improvement due to the potential reduction in government bond supply, but they foresee that more time will be needed to bring about changes in market sentiment.

According to the bond industry on the 26th, 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), which reflects investor sentiment in bond issuance, stood at 135 basis points (1bp=0.01%P) as of the previous day. The credit spread showed a vertical rise from around 60bp at the beginning of this year to 100bp amid the full-scale interest rate hikes. Recently, the payment guarantee crisis of Gangwon-do Legoland asset-backed commercial paper (ABCP) shook the short-term money market, causing the credit spread to jump more than 30bp within a month. Although the delayed payment amount of 205 billion KRW is not very large, the fact that a local bond equivalent to government bonds declared default sharply froze investor sentiment in the bond market. In terms of absolute interest rates, as of the previous day, the 3-year corporate bond with a high credit rating of AA recorded 5.52%, AA- was 5.57%, and A- was 6.48%, showing a slight increase compared to a month ago.

The government expects rapid stabilization of the bond market by introducing the card of reducing government bond supply following the large-scale liquidity support policy exceeding 50 trillion KRW announced last weekend. However, experts have a different view. They believe that investor sentiment in the credit market may not improve as quickly as expected. Since the government policy is focused on easing the tight short-term money market, it is judged that it will take more time for the positive effects to be reflected in the corporate bond market. In fact, right after the COVID-19 pandemic in 2020, the credit spread surged to the 70bp range, but it took 4 to 5 months after the launch of the bond market stabilization fund in April to narrow down to the 40-50bp range.

The card of reducing government bond supply is also expected to have little impact on market sentiment. While the reduction in supply volume may partially contribute to market interest rate stabilization, it is judged that there will be little effect because the bond market instability was not triggered by supply-demand issues. A bond management industry official emphasized, "The contraction of investor sentiment is rooted in credit risk," adding, "Considering that institutions began early book (fund) closing from August to September due to concerns about interest rate hikes and that bond fund redemptions increase toward the year-end, it is difficult to expect a reduction in credit spreads."

For institutions to actively open their wallets in the credit market, the fundamental issue of 'interest rate uncertainty' needs to be resolved. The turning point is the December Federal Open Market Committee (FOMC) meeting. While a giant step (a 75bp interest rate hike at once) is likely at the November FOMC, if a big step (a 50bp hike) is decided in December, expectations for a slowdown in the pace of rate hikes may increase. In this case, investor sentiment is predicted to improve significantly, especially for high-quality bonds with increased interest rate attractiveness in the first half of next year. Labor-gil, a researcher at Shinhan Investment Corp., said, "The decline in the global manufacturing PMI is leading to expectations of a slowdown in the Federal Reserve's tightening pace," adding, "Given that the U.S. manufacturing economy has contracted so rapidly that concerns about deflation rather than stagflation have arisen, the argument for a slowdown is gaining strength."

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