[Financial Planning for the 100-Year Life] Time to Increase Bond Investments Is Approaching

Possibility of Market Interest Rates Declining Again
Reduce Bank Deposits and Increase Bond Investments

Recently, market interest rates have been rising. However, considering the macroeconomic factors that influence interest rates, market interest rates are expected to decline in the medium to long term. It is a good time to increase bond investments.

The representative long-term market interest rate in the financial market is the yield on 10-year government bonds. This rate fell from 4.6% in October 2022 to 3.2% in February this year. However, it has recently surpassed 4% again. The rise in consumer prices in August, which increased by 3.4% compared to the same month last year and was higher than July's 2.3%, mainly due to the rise in international oil prices, has been a key factor driving the interest rate increase. Additionally, the U.S. 10-year Treasury yield rose to 4.5%, marking the highest level since October 2007, which also contributed to the rise in our interest rates. With inflation rates remaining high in September, market interest rates may rise further.

However, market interest rates are expected to decline again from the mid to late fourth quarter at the earliest. First, the current 10-year government bond yield of 4% appears to have exceeded an appropriate level. In the long term, market interest rates have been slightly below the nominal Gross Domestic Product (GDP) growth rate. For example, between 2001 and 2022, the average 10-year government bond yield was 3.9%, lower than the nominal GDP growth rate of 5.7%. According to my estimates, South Korea's potential nominal GDP growth rate in 2023 is about 3.7%. The more market interest rates deviate upward from this level, the greater the likelihood of a decline.

Next, savings rates and investment rates influence interest rates. From the perspective of the entire national economy, savings represent the supply of funds, and investment represents the demand for funds. Before the 1997 foreign exchange crisis, the gross domestic investment rate was higher than the total savings rate. Therefore, demand for funds exceeded supply, maintaining high interest rates. However, since 1998, the savings rate has exceeded the investment rate. In the first half of this year, the total savings rate was 34.1%, 1.4 percentage points higher than the gross domestic investment rate of 32.7%. Although this is lower than the long-term average of 3.2 percentage points from 1998 to 2002, the national economy as a whole still has a surplus of funds.

Bank bond purchases are also expected to contribute to the decline in interest rates. Banks manage funds through loans and securities when money flows in. Households are fundamentally surplus fund entities. According to the Bank of Korea's flow of funds, households (including non-profit organizations) had surplus funds of 183 trillion won last year. Corporations are fund-deficit entities. Last year, the scale of corporate fund deficits increased significantly to 176 trillion won. However, on the other hand, as of the end of March this year, corporate cash assets amounted to 909 trillion won. Corporate demand for funds is expected to decrease going forward.

When loans decrease in fund management, banks inevitably increase investments in securities. Banks emphasize stability over profitability in asset management, so they invest more assets in bonds than in stocks. As of the end of March this year, the proportion of stocks in banks' assets was 3.5%, down from a peak of 4.2% at the end of 2014. However, the proportion of bonds increased from 12.8% to 14.7% during the same period.

Market interest rates are already higher than appropriate levels, and considering the factors influencing interest rates, there is a high possibility of a decline in the medium to long term. Looking at individual financial asset management, the proportion of bank deposits (including cash), which was 43.4% at the end of 2021, rose to 46.9% at the end of March this year. This was because interest rates were high last year, with one-year bank deposit rates exceeding 5% at times.

The proportion of bonds increased from 2.3% to 3.0% during the same period but remains lower than the past average (4.6% from 2008 to 2022). To increase the return on individual financial asset management, it would be better to reduce the proportion of bank deposits somewhat and increase the proportion of bonds accordingly. Regarding loans, variable-rate loans seem preferable to fixed-rate loans, especially for longer maturities.

Kim Young-ik, Adjunct Professor, Graduate School of Economics, Sogang University

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