Longer-dated govt bond yields creep up as investors foresee more treasury sales

South Korea’s government bond yields are heading north despite the gloomy business outlook as institutional investors expect more government-issued treasuries to finance projects aimed at revitalizing the sagging local economy. Less chance of further policy rate cuts by the Bank of Korea is also prompting bond investors to unload their holdings.

According to the Korea Financial Investment Association, the yield on the 10-year government bond rose for a sixth straight session to close at a five-month high of 1.58% on September 1. That’s the highest close since 1.65% on March 25. In August alone, the 10-year bond yield rose 22 basis points.

The yield differential with the 3-year treasury note has widened to 0.61 percentage points as of Tuesday, posting the widest gap since September 3, 2015.

Longer-dated treasuries – 20-year notes and 30-year notes – finished Tuesday at yields of 1.73% and 1.72%, respectively, inching closer to the year-high levels seen in March, when the economy started to feel the impact of the COVID-19 pandemic.

SALE
Yields, which move in the opposite direction of bond prices, tend to decline in line with lower market interest rates when the economy is in a slump. However, state bond yields are rising as investors are selling bonds on expectations that the government will issue more treasuries.

Analysts say institutional investors also dumped treasury bonds following the government's record budget deficit proposal for next year to jump-start the economy. The finance ministry said the government is proposing another supersized budget of 556 trillion won ($470 billion) for 2021. To cover the public finance deficit, the ministry said it is considering 90 trillion won in net debt issues.

The government spending plan was unveiled the same day the Bank of Korea announced that the country’s economy contracted 3.2% in the second quarter from the year-earlier period – its worst performance in nearly 22 years.

MORE TREASURIES IN THE PIPELINE

The financial market expects the government to issue more than 160 trillion won in new state bonds annually in the coming years to address the broad and lasting economic impact of the ongoing pandemic. From 2017 to 2019, the government sold an average of 100 trillion won a year in treasuries.

According to Meritz Securities analyst Yoon Yeo-sam, the government will likely issue 170 trillion won in treasuries in 2021, following this year’s 168 trillion won issued.

“Given the size of the planned bond issues, yields could rise further for the rest of this month,” he said.

The rise in government bond yields may cool the recovery of the local economy as higher borrowing costs will dampen corporate investments.

“Higher yields will not only burden the government’s future bond issuance plans but also weaken the policy effect of the Bank of Korea’s low interest rates for enterprises,” said Gong Dong-rak, an economist at Daishin Securities.

BOK UNLIKELY TO STEP IN

Some participants in the domestic bond market have raised the prospect of central bank intervention if long-term bond yield curves stiffen. But BOK Governor Lee Ju-yeol dismissed such a possibility, saying that the central bank would be prudent in purchasing treasury bonds from the market.

Analysts expect weak demand for treasuries in the market to push yields higher.

“Without treasury purchases by the central bank, bond yields will rise further, given the current supply and demand situation,” said Kim Myung-sil, an analyst at Shinhan Investment Corp.

Write to Tae-Ho Lee and Ik-Hwan Kim at thlee@hankyung.com