Growing Momentum for July US Interest Rate Hike... Bond Yields Gradually Rising

3-Year Korean Treasury Bonds Rise 20bp Since Last Month
September FOMC Rate Hike Talk Emerges... Experts Say "Unlikely"
Korean Inflation Relatively Low, BoK Expected to Maintain Hold Policy

[Image source=Yonhap News]

As the U.S. economy shows stronger-than-expected performance, expectations are rising that the Federal Open Market Committee (FOMC) will raise interest rates in July, causing domestic bond yields to fluctuate. If the Federal Reserve (Fed) intensifies its rate hike moves, it could trigger changes in the Bank of Korea's policy, which has maintained a rate-hold stance.

Whether the rate hike is in its final stage or not... 3-year government bond yields have risen 20bp this month

According to the Korea Financial Investment Association's bond information system, the 3-year government bond yield stood at 3.632% as of the morning of the 3rd. Since last month, government bond yields have been trending upward. On the 1st of last month, the 3-year government bond yield was 3.48%, but it has since risen by about 20bp (1bp = 0.01%). Compared to this year's lowest level of 3.11% (February 3), it has jumped more than 50bp.

Other bond yields have also risen across the board. Since the 1st of last month, the 3-year corporate bond (AA-) yield increased from 4.285% to 4.473%. The 3-year Korea Electric Power Corporation (KEPCO) bond yield fell more than 110bp from 4.7% at the start of the year to 3.6%, but after rising to the 4% range in May, it currently points to 4.2%. This reflects the shift in weight from a rate hold to a rate hike.

In June, the Fed left room for further tightening but ultimately kept the benchmark interest rate unchanged. The market focused on the hold decision and ruled out additional rate hikes. This outlook considered the U.S. economic situation, including the bankruptcy of regional banks. However, as U.S. economic indicators were released stronger than expected, the mood quickly reversed. Some expect that after a rate hike in July, there could be one more rate increase. There are four remaining FOMC meetings this year?in July, September, November, and December?and this implies that rate hikes could be decided in half of these meetings.

At the European Central Bank (ECB) annual forum, Fed Chair Jerome Powell mentioned the possibility of two rate hikes this year, solidifying the upward trend in bond yields. According to the CME FedWatch tool, the current U.S. policy rate is 5.00?5.25%, but the probability of the year-end terminal rate rising to 5.25?5.50% is close to 88%. The chance of it rising to 5.50?5.75% is also in the 20% range. On the 5th and 7th, the minutes of the June FOMC meeting and June employment data are scheduled to be released. If the minutes contain hawkish content or there is an employment surprise, the rate hike stance is expected to strengthen further.

Low possibility of a rate hike at the September FOMC

Domestic securities firms have also begun revising their rate forecasts. Earlier, Daol Investment & Securities predicted no further U.S. rate hikes this year and set the year-end terminal rate at 5.25%, but recently revised it to 5.5%. This is based on the judgment that most factors that had prevented rate hikes have been resolved. Huh Jeong-in, a researcher at Daol Investment & Securities, said, “The mass withdrawal (bank run) at small banks has been settled, and although concerns about commercial real estate risks remain, vacancy rates and price declines have shown signs of stabilization,” adding, “Skipping the July hike would rather increase market anxiety.”

However, there is skepticism about a September hike. Since inflation is moderating, another rate increase could raise concerns about financial instability. Accordingly, the dominant view is that the Bank of Korea will maintain its rate-hold stance regardless of the U.S. rate hike in July. Ahn Ye-ha, a researcher at Kiwoom Securities, explained, “Additional rate hikes would ultimately burden the real economy,” and “Since Korea’s inflation rate is lower compared to other countries, the Bank of Korea is likely to maintain the hold.” Market experts estimate that the domestic inflation rate for June, to be announced on the 4th, has entered the 2% range due to price reductions by food companies. In contrast, the Eurozone’s June inflation rate is in the 5.5% range.

The Bank of Korea’s rate-hold stance is expected to continue until the end of the year. Accordingly, bond yields such as government bonds are also unlikely to show significant changes. Even if the Fed changes its rate policy, it does not mean there will be an opportunity to buy bonds cheaper than now (bond yields and prices move inversely). Kim Ji-man, a researcher at Samsung Securities, analyzed, “The room for further rate increases is limited to around 10bp, so it is appropriate to approach buying at the current rate level,” adding, “Even if an additional supplementary budget is announced, the market has long been wary of this factor, so the impact will be limited.”

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