The Influence of US Treasury Yields Has Grown Larger During Monetary Tightening Periods

Increase in Korea-US Financial Connectivity Due to Expansion of Overseas Securities Investment
Domestic Investors Show Stronger Tendency to Follow US Interest Rates
US Treasury Yield Impact Expected to Remain High

[Image source=Yonhap News]

An analysis has emerged showing that the extent to which South Korea's long-term government bond yields are influenced by U.S. Treasury yields has significantly increased since 2022, a period of global monetary tightening.

According to the Bank of Korea's 'Bok Issue Note: Background and Assessment of the Expanded Domestic Impact of U.S. Treasury Yields during the Recent Global Monetary Tightening,' released on the 1st, South Korea's long-term government bond yields have shown increased synchronization with U.S. long-term Treasury yields compared to other countries during the global monetary tightening period.

During the global monetary tightening period (January 2022 to February 2024), the correlation coefficient between South Korea's and the U.S.'s long-term government bond yields (10-year) was found to be 0.94. This marks a significant rise from the previous period (January 2013 to December 2021), which was 0.61.

Compared to other major foreign countries, the influence of U.S. Treasury yields has also increased. During the same period, South Korea ranked fifth in terms of influence on domestic yields at 58%, following Australia (70%), Canada (67%), Singapore (66%), and New Zealand (60%). This is higher than the average of major advanced countries, which stands at 48%. A higher percentage indicates that U.S. Treasury yields have a greater influence than domestic yields.

The report categorizes five main factors behind the expanded influence of U.S. Treasury yields.

First is the strengthening of financial linkages with the U.S. South Korea's financial linkage with the U.S. was similar to that of emerging countries immediately after the global financial crisis but has recently shown synchronization with advanced countries. In particular, the significant expansion of residents' overseas securities investments has further strengthened financial linkages. South Korea's government bond futures market has grown into a market prioritized by global investors (investment banks, hedge funds, etc.) alongside Australia when managing portfolios in the Asia region.

Second is the policy rate synchronization among major countries due to the global high inflation shock. In 2022, major countries experienced expanded inflation instability due to geopolitical risks, supply chain restructuring, and rising oil prices. Consequently, policy rates were raised at an unprecedented pace. Long-term government bond yields are influenced by current policy rate levels and market expectations of future policy rates, which led to a significant increase in long-term yields among major countries.

The strengthened tendency of domestic investors to follow U.S. interest rates also had an impact. Investors who had observed the high synchronization between Korean and U.S. interest rates until 2022 formed rigid expectations, increasing the tendency to follow U.S. Treasury yields. Simultaneously, the magnitude of shocks from U.S. Treasury yields to the domestic bond market expanded compared to the past. This was because the U.S. Federal Reserve (Fed) emphasized the principle of forward guidance, causing U.S. Treasury yields to be influenced by economic news and statements from Fed officials.

Additionally, increased trading by foreign investors in the government bond futures market who tend to follow U.S. Treasury yields, and the strengthening of the U.S. dollar which intensified global risk aversion sentiment and worsened domestic financial institutions' funding conditions, also played key roles.

The report forecasts that the influence of U.S. Treasury yields will remain at a high level going forward. Koo Byung-soo, head of the Bond Market Team at the Bank of Korea's Financial Market Department and author of the report, stated, "Considering the strong financial linkage with the U.S. and investors' tendency to follow U.S. Treasury yields, the spillover effect of U.S. Treasury yields is expected to remain high for the time being. If long-term government bond yields show high volatility due to U.S. Treasury yields during the future pivot in Korea-U.S. monetary policies, domestic financial conditions may be affected."

He added, "However, there have been instances where the influence of U.S. Treasury yields on long-term yields diminished when expectations for domestic monetary policy diverged from those of the U.S. If global monetary policy differentiation based on country-specific inflation and economic conditions intensifies in the future, the influence of U.S. Treasury yields may somewhat decrease."

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