US government bond yields have been a big deal in the economy lately. Bond yields in the United States have risen sharply from six months ago. Such a rise in US bond yields has been rare over the past two decades. Around the same time last year, U.S. Treasury yields fell, as the market gripped by fears about the outbreak of the COVID-19 pandemic. Now, the rise in bond rates seems to indicate that the market has returned to normal. This could be seen as a sign of economic recovery, but many analysts say rising bond yields are not always good for the market.
It may seem that US bond yields have little to do with Korea. But they can influence interest on Korean loans and mortgages as well as the Korean economy. Here is Kim Gwang-seok from the Institute for Korean Economy and Industry discussing what the changes in US bond yields mean and how Korea should face them.
A document that verifies a debt is an IOU. It includes the details of the loan and its payments. Governments and businesses can borrow money if needed. In this case, they issue an IOU, otherwise known as a surety. If a government issues a bond, it is called the government bond.
If a company issues a bond, it is called a corporate bond. Like a loan, a bond earns interest.
Government bonds are considered safe assets. When the economy is not looking good, investors are more interested in safe-haven investments like government bonds, which leads to lower bond yields. In contrast, when the economy shows signs of improvement, investors tend to exit the bond market and seek riskier and more profitable alternatives, resulting in higher bond yields. Thus, a rise in government bond rates is interpreted as a sign of economic recovery.
But why is the whole world particularly interested in US Treasury bond rates? This is because they could trigger interest rate hikes in other countries and their changes reflect the market situation. Lately, US bond yields have been trending higher.
With the accelerated deployment of the vaccine in the United States, consumer and business sentiment has returned to pre-pandemic levels. Key economic indicators such as exports and employment this month have improved markedly year over year, due to the statistical base effect. In addition, the Biden government’s massive stimulus package raises expectations of an economic rebound. These factors are putting upward pressure on US bond yields.
Economic recovery usually leads to greater consumption and higher prices. In other words, rising bond yields could be the harbinger of inflation. Central banks around the world are concerned about this part. They may consider raising key interest rates in order to control inflation, as a sharp rise in prices will have various side effects.
International eyes are once again on the United States. Many countries are monitoring whether the US Federal Reserve will raise its base interest rate sooner than expected and tighten monetary policy as an exit strategy.
Governments in many countries have actively provided liquidity to the market to help cushion the economic shock of the pandemic. They have also lowered interest rates, as low interest rates will encourage companies to increase their investment, stimulate consumption and boost employment.
But many countries have yet to recover from the COVID-19 shock. Some lucky countries have seen consumer and investor sentiment improve following the vaccine distribution, while some developing countries have yet to even introduce vaccines. In this situation, a rise in interest rates can come as a big shock to countries that are not yet prepared for the recovery. They still need to keep the interest rate trend low to boost their economies. But yields on US Treasuries are rising, widening the gap between the value of the US dollar and that of the currencies of some emerging economies. This could cause an outflow of capital from these countries.
Korean government bond yields also rose, in line with spikes in US bond rates. Attention is turning to whether the Bank of Korea will raise its policy interest rate due to concerns about inflation. The central bank said it did not intend to change its monetary policy. But analysts predict that a rise in interest rates will be inevitable if continued increases in US bond yields fuel inflation.
Rising interest rates will discourage companies from investing and exploring promising new industries. Many are also concerned about Korean household, business and government debt, which continues to rise. If economic actors have to pay more interest, they will refrain from economic activities including consumption. In other words, an increase in rates will impose a heavier interest charge on them, which will slow down the country’s recovery momentum.
However, there is another reason why it is difficult to prolong the trend of low interest rates. If interest rates in Korea are lower than in the United States, foreign capital will withdraw from the Korean market. This is why some emerging economies like Brazil, Turkey and Russia have raised their base interest rates. In fact, the International Monetary Fund has warned of capital outflows from developing countries due to rising US bond yields.
While South Korea is classified as an emerging economy, the country’s inflation is not very high. Thus, the local currency is unlikely to depreciate significantly and the possibility of a massive outflow of foreign capital is limited. However, the large 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 changes in advanced economies. Financial authorities should also consider strategies related to exports to emerging economies, given the possibility of an economic crisis in these countries.
Macroeconomic indicators can fluctuate wildly depending on changes in global interest rates. Korea should actively monitor the foreign exchange and stock markets and provide appropriate guidelines so that economic actors are not severely affected by market volatility.
Economic situations are becoming more and more complicated inside and outside Korea. Korea must revive the pandemic-stricken economy, manage ever-growing household and corporate debt, and prevent foreign capital from flowing out of the country. He should carefully monitor the development of US bond yields and devise measures to minimize the impact of the market turmoil.