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ECB bond-buying a big move, but not a game changer

January 26, 2015 16:46lJanuary 26, 2015 16:46
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Korean economy not as healthy as it appears

Although monetary easing has continued around the globe, led by the Eurozone, Korea has remained cautious against further monetary expansion. The Bank of Korea (BOK) sees its real GDP growth projection of 3.4% as painting a decent growth picture for this year, and believes an additional rate cut would aggravate the already-serious household debt problem. The BOK’s neutral tone is also supported by the Korean government’s focus on the positives in the economy, rather than the risks.

Nonetheless, the three-year KTB yield, now close to 2%, seems to reflect market expectations for an additional rate cut (to 1.75%). Although the sharp decline in global yields has surely contributed to such low yield levels, the main cause is the strong uncertainty over the Korean economy this year, in our view. All eyes are on the extent of economic recovery in 1Q, and more will be known when economic data are released. In the meantime, we maintain our expectation of an additional rate cut this year.

Rate cut expectations and flattened UST curve likely to push 10-year KTB yield below the 2.3% level

Last week, long-term KTBs were relatively bullish on the back of their time value and the decline in global yields. At market closing on January 23rd, the 10-year KTB yield hit a low of 2.33%, whereas the three-year KTB yield closed at 2.03%, vs. the pre-MPC meeting closing yield of 1.97%. With the three- and 10-year KTB yield spread narrowing to 30bp, the yield curve flattened further.

We have stressed that the KTB yield curve is determined by rate cut expectations and the UST curve. With both factors currently supporting curve flattening, we expect long-term KTBs to stay bullish for the time being. Once real demand from long-term investors is confirmed at the 20-year KTB auction (scheduled for this week), the 10-year KTB yield could fall below the meaningful 2.3% level, the lower end of the current range.

Rate cut expectations have remained intact because of unfavorable domestic economic conditions and the ECB’s quantitative easing (which it announced last week), keeping yields low in the domestic bond market. During the January MPC meeting, the BOK governor stated that Korea recorded weak GDP growth in 4Q14 (only 0.4% QoQ), but he emphasized that the anemic growth in the quarter resulted from exceptional circumstances: 1) the introduction of the Mobile Device Distribution Improvement Act and 2) fiscal spending cuts.

However, a careful look at the actual 4Q GDP growth data (announced on January 23rd) raises doubts as to whether the reasons behind the disappointing result were indeed exceptional
. Growth in both consumption and net exports slowed YoY for two consecutive quarters in 3Q and 4Q. In particular, in 4Q, the contribution of consumption to GDP growth hit the lowest level since 2009. Stripping away the GDP growth contribution of inventories, which reached 0.8%, overall GDP growth swung to negative territory in 4Q.
*Source: KDB Daewoo Securities Co.