[Practical Finance] Expectation of US Interest Rate Cut... Should We Invest in Bonds through ISA?

Growing Expectations for US Interest Rate Cuts in Q3 This Year
Uncertainty Remains Over Abolition of Financial Investment Tax Scheduled for Next Year
Government Bonds Recommended for Beginners in Bond Investment

As expectations for a Federal Reserve (Fed) interest rate cut in the third quarter grow, more investors are looking to include bonds in their portfolios. In particular, with the implementation of the financial investment income tax (Geumtu Tax) scheduled for January next year, there is strong demand to invest in bonds through Individual Savings Accounts (ISA), known as 'tax-saving accounts.' The proportion of bonds within assets managed under the 'brokerage-type ISA' products, which are directly managed by individual investors, has exceeded 7%. Experts recommend long-term bonds with higher yields over short-term bonds, given the significant changes in interest rate policies.

Bond Proportion in Domestic Brokerage-type ISA Surpasses 7%

According to the Korea Financial Investment Association on the 22nd, as of the end of March, the amount invested in bonds through brokerage-type ISAs reached 844.2 billion KRW. This accounts for 7.2% of the total managed assets. Adding 19 billion KRW invested in domestic and foreign bond funds increases the total to approximately 860 billion KRW. The bond proportion has steadily increased since March last year when the revision of the Restriction of Special Taxation Act allowed direct bond investments through ISAs.

Under the current system, interest and dividend income generated within an ISA account are tax-exempt up to 2 million KRW (4 million KRW for the low-income type). Even if the amount exceeds this limit, a low tax rate of 9.9% is applied. The Ministry of Economy and Finance has announced plans to increase the tax-exempt limit to 5 million KRW for the general type and 10 million KRW for the low-income type, which is 2.5 times the current limit, through a law amendment early next year. However, whether individual bond investments can be made using an ISA account depends on the product and company, so prior confirmation is necessary.

The financial investment income tax to be introduced next year is a driving factor stimulating market interest in ISAs, which offer significant tax benefits. The Geumtu Tax imposes a 20% tax (25% on income exceeding 300 million KRW) on income from stocks, funds, bonds, derivatives, and other financial products. Although President Yoon Seok-yeol is pushing for the abolition of the Geumtu Tax, the need for legislative amendments makes the outcome uncertain. Until now, only interest income from bonds has been taxed. With the introduction of the Geumtu Tax, capital gains from bond trading will also be subject to taxation.

Meanwhile, recent developments in the bond market have revived expectations that the U.S. interest rate cut is within sight. On April 14 (local time), the U.S. Consumer Price Index (CPI) for April showed a slowdown in inflation for the first time this year. The April CPI rose 3.4% year-on-year, a 0.1 percentage point decrease from the previous month, aligning with market expectations. The month-on-month increase was 0.3%, below the market forecast of 0.4%. The core CPI matched expectations, rising 0.3% monthly and 3.6% annually. With inflation easing, an interest rate cut in the third quarter has become a possibility. Typically, bond yields and bond prices move inversely.

Should You Buy Treasury Bonds? Consider Long-term Bonds for Capital Gains

If you are new to bond investing, it is recommended to start with Korean won-denominated bonds, particularly treasury bonds. Foreign bonds require consideration of exchange rates, and treasury bonds are easier to approach than corporate bonds. In situations like the current pivot (policy shift), interest in long-term bonds increases because their price volatility is greater than that of short-term bonds. Baek Seung-hwa, head of the bond product division at Hana Securities, explained, "When interest rate cuts become full-scale, the price increase of long-term bonds tends to be higher than that of short-term bonds. If you have a longer investment horizon and are actively managing bonds, you can buy long-term bonds to aim for capital gains."

If you consider a shorter investment period, short-term bonds are also a good option. For example, low-coupon treasury bonds can offer higher yields than regular savings deposits. Assuming a 2-year treasury bond yield of 1.25%, investing 10 million KRW would allow you to purchase the bond at 9.65 million KRW. At maturity after two years, you receive 10 million KRW. Capital gains from trading are tax-exempt, so only interest income is subject to a 15.4% tax. Baek added, "For those new to bond investing, assuming the Geumtu Tax is deferred, short-term treasury bonds with yields comparable to bank savings are recommended. However, once the Geumtu Tax is introduced next year, capital gains will also be taxed, potentially lowering yields below those of regular savings deposits." He emphasized the need for strategies considering tax-saving effects, as the final yield can vary significantly with the Geumtu Tax.

If you have a large investment scale and hold dollar assets, investing in U.S. Treasury bonds is also an option. The 10-year U.S. Treasury yield fell to around 4.45% before rebounding to about 4.5%. At the end of last month, it surged to the mid-4.7% range but dropped to the mid-4.3% range after the April CPI release. This influenced South Korea's 10-year treasury bond yield, which fell from the mid-3.7% range to the mid-3.4% range. Even without dollar assets, investors can access U.S. bonds through exchange-traded funds (ETFs). Among bond ETFs listed on the U.S. stock market, the most favored product is the 'iShares 20+ Year Treasury Bond ETF (TLT),' which is the largest in terms of assets under management among U.S. long-term bond ETFs. In Korea, the 'ACE U.S. 30-Year Treasury Active (H)' ETF by Korea Investment Trust Management is representative, attracting investor interest with net assets of 1.1296 trillion KRW within one year of listing. This ETF pays monthly dividends. The 'TIGER U.S. 30-Year Treasury Strap Active (Synthetic H)' is also one of the large U.S. bond ETFs in terms of net assets.