Alarm about a short-lived Goldilocks economy in the United States, sparked by an ominous sign in the U.S. Treasury debt yield curve, has spilled over to the Korean market to flag a flat curve for the first time in more than two years.
The 10-year Korean Treasury bond closed Wednesday at 2.058 percent, down 4.4 basis points from the previous session to its lowest since November 2016. The three-year note yielded 1.901 percent to finish 1.3 basis points lower. This brought the gap between the two to 15.7 basis points, the thinnest since 15.1 basis points on Sept. 30, 2016.
The longer-term Korean bond yields continued to fall faster than the shorter ones. The yield on 10-year government debt finished Thursday 7.5 basis points lower, the 20-year 9.0 basis points lower, and the 30-year 8.9 basis points lower, while papers dated five years and shorter fell around 6 basis points.
On Monday, the U.S. Treasury yield curve inverted, an atypical situation where the long-dated papers yield lower than the short-term ones, with the yields on two- to three-year notes exceeding those of five-year maturity for the first time in 11 years. The following day, the spread between yields on two- and 10-year notes narrowed to 1.1 basis points, the smallest since 2007.
An inversion has occurred six times in the U.S. since 1970, and each time it was followed by a recession. The latest one was the global financial crisis in 2008.
Long-term bonds typically offer higher yields than short-term ones to compensate for the risk of inflation and changing interest rates. Shifting to longer-term debt is an indication of growing pessimism about the immediate economic outlook. As more investors hold a gloomy outlook of the economy, they tend to invest in longer-term securities to secure the current high yields before interest rates scale down. This increased demand for longer-term bonds drives up their prices and lowers their yield, as yields move in the opposite direction to bond prices.
If the yield of long-term securities drops further, it could reach a point where long-term rates fall below short-term ones - a phenomenon known as an inverted yield curve.
The Korean government debt yield had started off strong at the beginning of the year. But the escalating trade war between China and the U.S. and concerns about slowing growth began to rattle markets. Korea’s dismal employment and investment figures also raised fears of an economic slump, putting a downward pressure on the yield. Sluggish stock performance also drove more investors to the safer government debt.
The Bank of Korea on Nov. 30 raised the benchmark rate to 1.75 percent, its first hike in a year, but market rates are continuing to fall amid the cloudy economic outlook. Experts say long-term rates could slide further as local economic conditions show little sign of picking up.
By Jang Yong-seung and Kim Hyo-jin
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