Looking for a dovish BOK; US bond rally stalls

BOK will stay on hold for the time being before moving to cut rates in 3Q. US bond rally stalls on weak 7Y auction.
Eugene Leow, Ma Tieying30 May 2019
    Photo credit: AFP Photo

    South Korea: Looking for a dovish BOK

    The Bank of Korea is expected to maintain status quo on monetary policy at tomorrow’s meeting, but with a dovish tone. The call for monetary easing has been growing in the last few weeks, with the state-run think tank Korean Development Institute said in its biannual report that monetary policy needs to be “substantially accommodative” to counter slowing inflation and sluggish domestic demand. Meanwhile, the BOK board member Cho Dong-chul also expressed concerns over the phenomenon of extremely low inflation.

    Indeed, inflation has been running below the official target by a wide margin, providing justifications for the BOK to cut rates to bolster price expectations and boost domestic demand. Headline and core CPI registered only 0.6% YoY and 0.9% respectively in April, compared to the BOK’s medium-term target of 2%. Property prices have also started to ease since the beginning of this year, thanks to the cooling measures introduced by the government.

    Meanwhile, the BOK’s 2019 growth forecast of 2.5% faces significant downside risks. Although April indicators like PMI and exports show improvement, slowdown risks increased again in May due to the reescalation of China-US trade war/tech war. Given South Korea’s close trade and investment ties with both China and the US, the spillover effects on its broad economy cannot be underestimated.

    The ongoing currency depreciation (6.5% vs USD YTD) could be a hurdle for immediate rate cuts. The KRW’s decline has quickened since late-April, initially due to the 1Q GDP disappointment and then due to the escalation of China-US trade war and North Korea’s missile tests. The pace of depreciation has caused discomfort among South Korea’s policymakers, with the finance minister warning last week that the government will take steps to stabilise the FX market in case of excessive one-way movement.

    We think the BOK will stay on hold for the time being before moving to cut rates in 3Q. Our year-end forecast for the benchmark repo rate is maintained at 1.50%.

    Rates: Weak 7Y auction stalls the US bond rally     

    10Y US Treasury yields rebounded in the second half of the trading day to close just about unchanged at 2.26%, up 6bps from its intraday low. Ostensibly, this was blamed on the weak 7Y auction that drew bid-to-cover of 2.30 (and tailed by 2bps), levels not seen 2016. However, we should also note that earlier auctions of the 2Y and 5Y tenors saw decent demand. It appears that investors may be turning cautious after the breakneck rally over the past 6-7 weeks as 10Y yields tumbled by 34bps from its April peak. The rally from 2018’s peak is even more impressive, registering close to 100bps.

    We still think that US yields will be held down in the short term. The technical picture is still supportive of higher bond prices with a series of lower lows (for yields) over the past few quarters. As trade war drags, news narrative can easily turn more negative with either China retaliating or the US upping the ante with more tariffs (or non-tariff measures). Moreover, yield is in short supply in the developed market world. The total stock of negative yielding bonds has crossed USD 11tn and is fast approaching the all-time high of 12.2tn registered in mid-2016. For a meaningful move higher in US yields, we would first have to see some signs of stabilisation in the global economy and in DM (especially Eurozone) yields.

    Ma Tieying

    Economist - Japan, South Korea, & Taiwan

    Eugene Leow

    Rates Strategist - G3 & Asia

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