U.S. government bond yields have been in the economic news a lot lately. Bond yields in the U.S. have risen sharply, compared to six months ago. Such a steep spike in U.S. bond yields has been rare over the last two decades. Around this time last year, U.S. treasury yields plummeted, as the market was gripped by fears about the outbreak of the COVID-19 pandemic. Now, the upturn in bond yields seems to indicate that the market is back to normal. It could be viewed as a sign of economic recovery, but many analysts say that rising bond yields are not always good for the market.
It might seem that U.S. bond yields have little to do with Korea. But they can have an influence on interests on credit loans and mortgage loans in Korea as well as on the Korean economy. Here is Kim Gwang-seok at the Institute for Korean Economy and Industry to discuss what the changes in U.S. bond yields mean and how Korea should cope with them.
A document that verifies a debt owed is an IOU. It includes the details of the loan and its payments. Governments and companies may borrow money when necessary. In that case, they issue an IOU, which is otherwise called a bond. If a government issues a bond, it is called the government bond.
If a company issues a bond, it is referred to as a corporate bond. Like a loan, a bond pays interest.
Government bonds are regarded as safe assets. When the economy is not in good shape, investors are more interested in safe haven investments like government bonds, causing bond yields to decline. When the economy shows signs of improving, on the other hand, investors tend to leave the bond market and look for riskier and more profitable alternatives, leading to a rise in bond yields. So, a hike in government bond rates is interpreted as a sign of economic recovery.
But why is the entire world paying attention to the U.S. Treasury bond rates, in particular? That is because they could trigger interest rate hikes in other countries and their changes reflect the market situation. As of late, U.S. bond yields have shown an upward tendency.
Thanks to the accelerating vaccine rollout in the U.S., consumer and business sentiments have recovered to the levels before the pandemic. Key economic indicators such as exports and employment this month have clearly improved year-on-year, due to the statistical base effect. Also, the Biden government’s massive stimulus package is raising expectations for an economic rebound. These factors are putting upward pressure on U.S. bond yields.
Economic recovery generally leads to greater consumption and rising prices. That is, rising bond yields could be the herald of inflation. Central banks around the world are concerned about this part. They may consider raising key interest rates in order to tame inflation, since a sudden increase in prices will generate various side effects.
International eyes are again on the U.S. now. Many countries are watching if the U.S. Federal Reserve will raise its base interest rate earlier than expected and tighten its monetary policy as an exit strategy.
Governments in many countries have actively provided liquidity to the market to help cushion the economic shock from the pandemic. They have also cut interest rates, because low interest rates will encourage companies to increase investment, stimulate consumption and boost employment.
But many countries have yet to recover from the COVID-19 shock. Some fortunate countries have seen consumer and investment sentiments improving, following the distribution of vaccines, while some developing countries haven’t even brought in vaccines yet. In this situation, a hike in interest rates may come as a great shock to the countries that aren’t prepared for recovery yet. They still have to maintain the low interest rate trend to invigorate their economies. But yields on U.S. Treasury bonds are rising, widening the gap between the value of the U.S. dollar and that of the currencies of some emerging economies. This could prompt a capital outflow from those countries.
The return on Korean government bonds has also been on the rise in sync with spikes in U.S. bond rates. Attention turns to whether the Bank of Korea will raise its key interest rate out of inflation concerns. The central bank has said that it has no plan to change its monetary policy. But analysts predict that an interest rate increase will be inevitable if the continued hikes in U.S. bond yields stoke inflation.
A hike in interest rates will discourage companies from making investments and exploring new, promising industries. Many are also concerned about Korea’s household, corporate and government debt, which continue to rise. If the economic players have to pay more interest, they will refrain from economic activities including consumption. In other words, a rate increase will place heavier interest burden on them to dampen the country’s recovery momentum.
Nevertheless, there is another reason that it is difficult to prolong the low interest rate trend. If interest rates in Korea are lower than those of the U.S., foreign capital will pull out of the Korean market. That’s why some emerging economies such as Brazil, Turkey and Russia have raised their base interest rates. In fact, the International Monetary Fund has warned of capital outflows from developing countries as a result of rising U.S. bond yields.
While South Korea is classified as an emerging economy, the country’s inflation is not very steep. So, the local currency is unlikely to depreciate sharply and there is limited possibility of a massive outflow of foreign capital. Yet, major Asian countries including Japan are preparing to tighten their monetary policy internally.
Korea should be more careful when making decisions on monetary policy measures, while closely monitoring any policy change in advanced economies. The financial authorities also have to examine strategies related to exports to emerging economies, in consideration of the possibility of an economic crisis in those countries.
Macroeconomic indicators may fluctuate wildly in line with changes in global interest rates. Korea needs to actively monitor foreign exchange and stock markets and come up with proper guidelines so economic players will not be affected severely by market volatility.
Economic situations are becoming increasingly complicated inside and outside Korea. Korea needs to revive the pandemic-hit economy, manage the ever-increasing household and corporate debt and prevent foreign capital from flowing out of the country. It should carefully monitor the moves of U.S. bond yields and devise measures to minimize the impact of market turmoil.