Final Stage of Interest Rate Hikes... Last-Minute Long-Term Bond Buying Rally

No Interest Rate Cut Expected This Year... Rate Cut Likely Early Next Year
Gradual Long-Term Bond Purchases Advisable Whenever Rates Fluctuate

At the May Federal Open Market Committee (FOMC) meeting, the U.S. Federal Reserve (Fed) raised interest rates by 25 basis points (1bp=0.01 percentage point), marking the 10th consecutive rate hike. Although this outcome aligned with market expectations, the Fed indirectly signaled that the rate hike cycle is nearing its end by removing the phrase "additional tightening may be appropriate" from its statement. Concerns over regional bank failures and sluggish first-quarter gross domestic product (GDP) growth appear to have led the Fed to judge that further rate hikes could be detrimental to financial markets.

On the 3rd (local time), traders at the New York Stock Exchange (NYSE) in the United States are watching the press conference of Jerome Powell, Chairman of the U.S. Federal Reserve. Photo by Yonhap News

Accordingly, the bond market is expected to be crowded with individual investors trying to catch the last ride on rising rates. Retail bond investors have been responding to market conditions by purchasing long-term bonds since last year. Experts predict that this bond investment strategy will remain effective until the timing of rate cuts arrives.

"Current rates have peaked"... Individual investors buying long-term bonds

According to the Financial Investment Association's electronic disclosure system, from the 1st of last month to the 2nd of this month, individuals purchased a total of 4.3853 trillion KRW worth of bonds in the over-the-counter market. In January, net purchases were 2.929 trillion KRW, 2.8331 trillion KRW in February, and 2.9933 trillion KRW in March, with net purchases increasing by about 1.5 trillion KRW last month. Notably, in April, individual bond investments exceeded those of insurance companies (3.8153 trillion KRW) and funds (2.8525 trillion KRW). This year, individuals' net bond purchases totaled 13.0407 trillion KRW, a 392% increase compared to 2.6486 trillion KRW during the same period last year.

As the Fed's rate hike intensity weakens and expectations for rate cuts within the year are reflected, interest rates have fallen sharply compared to the second half of last year. However, under the perception that "current market rates have peaked," more investors have entered the bond market.

Among individual investors' bond portfolios, government bonds held the largest share. In January, individual investors' net purchases of government bonds were 463.2 billion KRW, but last month this increased to 1.5972 trillion KRW, more than tripling. Investor sentiment favored long-term government bonds with maturities over 20 years. Looking at the overall proportion, funds directed toward ultra-long-term government bonds such as 20-year and 30-year treasury bonds accounted for over 60% of total government bond investments.

Myungshil Kim, a researcher at Hi Investment & Securities, explained, "During the period of rapid rate hikes in the second half of last year, funds were concentrated mainly on short-term high-yield bonds. However, as the end of the rate hike cycle approaches and interest rates decline, individuals are turning to ultra-long-term government bonds that are expected to yield capital gains over the long term. The ability to safely invest funds until maturity is also seen as attractive." Particularly, with bank deposit rates (6 months to 3 years, in the 2-3% range) declining, bonds have become even more appealing.

Investors also continued bond investments through exchange-traded funds (ETFs) listed on the stock market. During the same period, the top net purchase items overwhelmingly consisted of long-term bond investment products. By item, the rankings were KODEX U.S. Treasury Ultra 30-Year Futures (20.1 billion KRW), ACE U.S. 30-Year Treasury Active (27.2 billion KRW), KBSTARKIS Treasury 30-Year Enhanced (26.1 billion KRW), TIGER Treasury 30-Year Strap Active (20.0 billion KRW), TIGER U.S. Treasury 10-Year Futures (9.3 billion KRW), and KOSEF Treasury 10-Year (9.0 billion KRW).

Funds targeting high-yield corporate bonds also increased. As market interest rate attractiveness declined, investors incorporated not only AA-rated high-grade bonds but also short-term A-rated or BBB+ rated corporate bonds into their portfolios. Last month, bonds issued by HD Hyundai Heavy Industries (A-; 31.5 billion KRW), SK Innovation (AA; 30.0 billion KRW), and GS Construction (A+; 24.9 billion KRW), which are expected to yield around 4%, appeared among the top net purchases by individual investors.

Interest in low-coupon bonds, which maximize tax benefits especially for high-tax-bracket asset holders, remained steady. Low-coupon bonds are government bonds that promise to pay about 1% annual interest (coupon rate) on the face value. Bonds issued during past low-interest-rate periods are currently priced well below face value. Due to the bond product characteristic where capital gains are tax-exempt and only interest income is subject to a 15.4% income tax, low-coupon bonds offer asset holders an investment option with potentially higher returns than bank deposits.

Powell keeps distance from rate cuts... Bank of Korea expected to cut rates in Q1 next year

When will the much-anticipated rate cuts occur? At the May FOMC, Chair Powell stated that factors influencing the FOMC include not only existing inflation, employment indicators, and wages but also the banking system and credit environment. Nevertheless, he clearly distanced himself from any rate cuts within the year. Kitae Ahn, a researcher at NH Investment & Securities, said, "Currently, the focus is on monitoring bank credit, but later the Fed's emphasized 2% inflation target will become the main monitoring signal."

The expected timing for rate cuts is early next year. For the current tightening cycle to transition to a cutting cycle, the sequence must be 'end of rate hikes → end of quantitative tightening → rate cuts.' Seungwon Kang, a researcher at NH Investment & Securities, noted, "At this meeting, the stance on quantitative tightening was maintained with no signs of change. While additional issues in the banking sector need to be monitored, a freeze this year and cuts early next year are likely." According to CME FedWatch, the possibility of rate cuts within the year begins with the September FOMC. Eol Shin, a researcher at SK Securities, said, "Unless a credit event at the level of systemic risk occurs, the possibility of Fed rate cuts within the year is extremely limited."

The Bank of Korea's expected timing for rate cuts is also more likely early next year than within this year. Although market concerns about a domestic economic downturn have grown, and the market hopes for a complete end to the tightening cycle and rate cuts in the second half, the Bank of Korea is also likely to maintain its rate freeze stance as the Fed delays a clear decision on the rate path. The interest rate differential between Korea and the U.S. has widened to a record 1.75 percentage points, increasing pressures such as capital outflows, but the Bank of Korea is expected to maintain its freeze stance reflecting economic concerns. Recently, Lee Chang-yong, Governor of the Bank of Korea, dismissed rate cut discussions as premature, stating, "We need to observe the monetary policy directions of major countries, and the direction of rates depends on data."

Gradual purchases of long-term government bonds until rate cuts

The current interest rate level reflects expectations that the rate hike cycle will end. Since rates have fallen significantly, it is harder to expect capital gains as before. However, as absolute interest rates remain in the 3% range, many experts suggest considering investments with rate cuts in mind.

Experts advise a dollar-cost averaging strategy of buying bonds incrementally whenever rates trend upward until rate cuts occur. Jiman Kim, a researcher at Samsung Securities, said, "There is still a lot of time before rate cuts. Since there is a possibility that government bond yields will rise above the base rate, investors should respond by buying bonds incrementally during rate increases rather than rushing purchases." A representative from a major securities firm added, "Rather than prematurely raising expectations for rate cuts and aiming for short-term gains, it is appropriate to focus on government bonds and high-grade corporate bonds that can generate steady profits. Demand for government bonds with maturities within two years will continue to flow in to maximize tax benefits."

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