[2020 Financial Weather Forecast] Lowered Possibility of Interest Rate Cuts... Bond Investment Appeal Drops Sharply

Lower Likelihood of Additional Base Rate Cuts Weighs on Bond Market
Rising Real Estate Prices Also Burden Base Rate Cuts
Economic Recovery Optimism Supports Weak Bond Prices View

[Image source=Yonhap News]

[Asia Economy Reporter Koo Eun-mo] The domestic bond market is expected to show weakness early this year. With the likelihood of a base interest rate cut being low for the time being and growing expectations for economic recovery, it is analyzed that bond prices will not easily rise.

According to the financial investment industry on the 3rd, the possibility of a short-term base interest rate cut this year is expected to be low. As the probability of a base rate cut decreases, bond prices are expected to fall. Bond prices have an inverse relationship with interest rates. When interest rates fall, bond prices rise, leading to a strong bond market, but when interest rates rise, bond prices fall, causing a weak bond market.

Bonds have fixed cash flows if held until maturity, but when bought or sold before maturity, the transaction price must be calculated by discounting future cash flows to present value. The discount rate used for present value is the interest rate currently traded in the market. If the interest rate is lower than the originally agreed coupon rate, the bond price rises; conversely, if the market interest rate is higher than the coupon rate, the bond price falls.

The low possibility of a short-term rate cut is analyzed to be due to the absence of factors warranting a cut in terms of growth and inflation. Huh Jung-in, a researcher at KTB Investment & Securities, explained, "To implement a rate cut, confirmation of economic downturn is necessary," adding, "The consecutive rate cuts in July and October last year were largely influenced by the consumer price index recording negative figures during that period." He further added, "Since the economic growth rate for Q4 last year is expected to grow by 0.6-1.0% quarter-on-quarter, and inflation for December last year and this month is forecasted at 0.6-0.8%, there are no trigger factors to accelerate the timing of a rate cut in terms of growth and inflation."

Shin Dong-soo, a researcher at Eugene Investment & Securities, also stated, "It takes time to confirm the effects of the two rate cuts implemented last year," and forecasted, "Currently, the possibility of the Bank of Korea delaying or freezing rate cuts until the second half has increased, which will strengthen the downward rigidity of interest rates."

The recent rise in real estate prices is also considered a burden factor for base rate cuts. Researcher Huh analyzed, "The recent acceleration in real estate price increases is due to a high liquidity environment based on low interest rates," adding, "Since time is needed to observe the effects of the government's December 16 real estate policy, a base rate cut that goes against government policy carries significant risks."

Gong Dong-rak, a researcher at Daishin Securities, also said, "The bond market should closely watch the fact that the government's determination to control the real estate market was reaffirmed in the December 16 real estate measures," adding, "The stronger the policy authorities' stance on real estate becomes, the more expectations for a base rate cut may change."

The improving perception of the economy, which was biased toward slowdown or stagnation last year, also supports the argument for bond market weakness. Researcher Gong said, "Although a dramatic rebound or a significant upward revision in growth rate is still difficult, expectations are forming that the economy will no longer worsen," adding, "A major change in economic perception is likely to cause bond market participants to worry about future increases in market interest rates or bond price adjustments." This suggests that the medium- to long-term investment strategy for bonds may shift from 'buy' to 'neutral' or reducing positions when prices rise.