Fixed income strategy: Walking on thin ice

The author is a bond strategist from Shinhan Investment Corp. He can be contacted at [email protected] — Ed.

The base rate will remain unchanged in February, but the upward pressure on KTB yields will continue ahead of the presidential election in March

The government will likely need additional budgets this year to support the economy. Given that excess tax revenue is unlikely to reach last year’s levels, we anticipate that most supplementary budgets will be funded by the issuance of KTB. While discussions on supplementary supplementary budgets will begin after the next government takes office, the run-up to the presidential election in March will provide clues about supplementary budget plans. As the campaign promises of the main presidential candidates take shape in mid-February, we expect to see further upward pressure on KTB yields due to concerns over a possible increase in supply at the future.

Meanwhile, the US Fed’s hawkish stance may weigh on the bond market on fears that the Bank of Korea (BOK) could become increasingly hawkish if the Fed makes four or more rate hikes this year. However, with its base rate already raised three times in the past five months, the BOK has some leeway to wait and see how the domestic economy performs before taking further action. Expecting the central bank to wait over the next two or three Fed rate hikes while monitoring economic trends to justify another rate change, we believe the base rate will remain unchanged at 1.25. % in February.

Focus on increasing volatility in KTB returns rather than price merit

Weak sentiment in the domestic bond market is expected to continue into February. The presidential election will get serious once the candidates start battling it out in televised debates. The economic outlook is not all bright as the Chinese economy faces growing uncertainties and tighter COVID-19 restrictions that are hurting consumer confidence. Nonetheless, we have yet to see any weakness in economic indicators severe enough to offset the expected upward pressure ahead of the presidential election and cause an actual drop in interest rates.

For February, we suggest a yield band of 2.00-2.25% for 3-year KTBs and 2.35-2.65% for 10-year KTBs. The 3Y-10Y yield spread is expected to move between 35-40bp. Interest rates should remain stable at the beginning of the month in the absence of monetary policy meetings at home and abroad. KTB yields, however, are likely to face further upside pressure as caution grows ahead of the March election. Even with prices increasingly attractive from the levels seen at the start of the year, we advise against rushing into a long position with volatility expected to increase in the short term.

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