Bond Curve in Korea Shows It May Finish Hiking When Others Start

(Bloomberg) -- South Korea led emerging Asian peers in kicking off monetary tightening. Now its yield curve is signaling the nation could finish raising rates when others are just getting started.

The yield spread between the 3- and 10-year Korean bonds has fallen 27 basis points this quarter, flattening the yield curve by the most among developing Asian nations. That reflects bets that the hiking cycle that began this year would end in 2022, just when others begin to lift rates, according to DBS Bank Ltd. 

“The relative flatness of the Korean yield curve is a function of market expectations that Korea’s hike cycle would be more front-loaded and shallow,” said Duncan Tan, a strategist at DBS Bank in Singapore. Hikes by other emerging-Asian central banks may begin in the second half of next year and stretch beyond 2023, he said. 

The flat Korean yield curve stands out in a region where rising inflation and relatively slower economic recoveries bolster curve-steepening bets. While won bonds are the worst performers after Thai debt this year, they may leap frog peers in the second half of 2022 when the other markets are in the midst of hiking cycles.

By contrast, the Philippine yield curve steepened the most in Asia as inflation hovers above the central bank’s 2%-4% target while it maintains a dovish stance. Central banks in the Philippines and Indonesia are expected to leave policy rates unchanged at Thursday’s rate decisions. Traders have garnered the best returns from markets including Thailand and Indonesia in the region in this quarter.

Economists surveyed by Bloomberg forecast a 25 basis points hike at Bank of Korea’s November 25 meeting. Hawkish bets have been on the rise after Governor Lee Ju-yeol strongly hinted at a possible increase last month. Inflation in October quickened to the fastest since 2012 due to rising energy prices and supply-chain bottlenecks. 

While major central banks have dismissed the price pressures as transitory, Governor Lee said it’s hard to gauge if that’s the case. Korea’s swap markets are pricing the most hawkish bets in emerging Asia. The one-year forward one-day rate indicates hikes of more than 100-basis points over the next 12 months. 

Shorter-dated Korean yields are also being swept up by a repricing of global rate expectations as U.S. inflation surged by the most since 1990. The 90-day correlation between 3-year Korean bonds and similar-dated Treasuries has risen to the highest since February 2020. 

That’s likely to add to the flattening pressure on the Korean yield curve, adding to its underperformance for now before a potential rebound next year.

©2021 Bloomberg L.P.