[ANALYSIS] Bond market sees fluctuation as election race heats up

A currency trader watches computer monitors near screens showing figures for the Kosdaq, lower left, and foreign exchange rates, in a foreign exchange dealing room in Seoul, in this file photo. AP-Yonhap

Foreign investors selling government bond futures

By Kim Yoo-chul

The country's bond market will see a continued fluctuation in terms of yields as the presidential election race in Korea heats up.

Investor sentiment in the local bond market already isn't that favorable, as recently released inflation data sent bond yields lower. The Bank of Korea (BOK) is also set to raise its benchmark interest rate by an additional 25 basis points at its planned November monetary policy meeting. With the country's inflation growth having risen to the bank's earlier target of 2 percent, bond market participants were saying that investors will sell off their bond holdings in Korea at an accelerated pace.

As a partial remedy to stabilize the bond market, the BOK and other financial authorities said they will reduce the amount of issuances for monetary stabilization, and added they will purchase more bonds this month. Plus, as was widely expected, the finance ministry had no options but to announce its plans to cut short-term government bond issuances for the following month.

Despite such collective efforts by the BOK and the finance ministry to lessen the volatility in the bond market, what's more of concern is the growing political uncertainty in Korea. But this time, the biggest risk factor isn't so much based on geopolitical concerns on the Korean Peninsula as much as internal political risk, given that the upcoming presidential election is expected to be contested fiercely.

Because of the country's moves to provide several rounds of disaster relief funds to citizens during the pandemic, funded by massive issuances of state bonds, the country's debt-to-GDP ratio has already worsened. By 2025, South Korea is expecting the ratio to be 58.8 percent, according to the finance ministry.

Last week, the bond market tumbled, which market participants said was due to remarks by Lee Jae-myung, presidential candidate of the ruling Democratic Party of Korea (DPK). Lee said that he will try to move forward with plans to give all citizens 1 million won ($850) in disaster relief funds.

Right after his remarks, yields of government treasury bonds with a three-year maturity ended last week at 2.103 percent, the highest level in 39 months after closing at 2.108 percent back in Aug. 3, 2018. Compared to the record-low ending on Aug. 5 with the same notes closing at 0.795 percent, last week's closing was an addition of 1.5 percentage points. The government's 10-year treasury note also spiked, to end at 2.575 percent ― also a record ― according to bond market participants.

"The bond market reacted very sensitively to DPK presidential candidate Lee's remarks regarding his idea of providing more disaster relief assistance to all citizens," one bond market participant said. Lee added later that it would be advisable for the government to provide at least between 300,000 won and 500,000 won to all citizens. "Regarding the specifics on how to get the funding to do this, it's a matter up for discussion between the party and financial authorities on whether or not to allocate a supplemental budget," he said.

Lee was ahead of both leading contenders of the main opposition party in various hypothetical matchups, according to a survey of 1,016 adults conducted from Oct. 29 to 30 by the Korea Society Opinion Institute (KSOI). Lee beat former Prosecutor General Yoon Seok-youl of the People Power Party (PPP) 33.2 percent to 32.4 percent. But the margin was thin, raising the possibility that Lee and the DPK camp may provide the details for another round of disaster relief funds.

Persisting worries

"If the government wants to provide 1 million won as helicopter money to all citizens, then I would say there will be at least 50 trillion won allocated through an additional budget. While the amount of money the government may offer citizens as pandemic relief could be slashed, one thing is that no imminent favorable factors are being seen in the bond market for the coming months," a bond dealer from NH Investment said, Monday.

Bank of Korea Governor Lee Ju-yeol responds to journalists' questions after its monetary policy committee left its benchmark rate unchanged in its October meeting. Courtesy of Bank of Korea

South Korea said earlier that it was planning to spend a record 604.4 trillion won next year ― an addition of 8.3 percent. Securities firms were saying they've been seeing decreased demand for bonds.

The continued pandemic has forced President Moon Jae-in's economic policy teams to compromise the country's fiscal goals, launching cash-intensive disaster relief fund campaigns in several additional fiscal outlays so far this year, followed by massive issuances of the government bonds.

"The BOK's November rate hike and planned additional hike for next year, along with the government's continued moves to maintain its expansionary fiscal policy, are forcing bond market dealers to close this year's trading earlier than expected. DPK presidential candidate Lee's remarks about the possible nationwide disaster relief campaign are just no good for us," another bond market dealer said.

Increases in the government's bond yields signify that unless the forecast rises for the country's top exporters' profits, shares are fated to decline in price so as to offer fair compensation for riskier assets. South Korea's stock market isn't that sensitive to bond yield fluctuations. However, according to the Korea Exchange, the country's bourse operator, overseas investors sold 7.4 trillion won worth of three-year maturity government futures this past October alone.

In September, foreign investors sold 15.03 trillion worth of government bond futures. Also, for the 10-year treasury transactions, foreign investors sold 2.4 trillion won worth of 10-year treasury bond futures in the local market.

"Because governments around the world are discussing how to explore the best possible ways to continue fiscal expansionary policies, central banks will continue increasing benchmark rates. That will force developed and emerging economies to suffer from persisting inflationary pressure," said Lee Mi-seon, an analyst at Hana Financial.