South Korean 3-year government bond yields remain confined to a 3.7-3.9% range, with market participants noting that the upper bound could extend to 4% based on a previous auction result. Bond dealers assess that concerns over a 'big step' rate hike have largely subsided following recent won-dollar exchange rate movements, though uncertainty persists regarding the possibility of consecutive rate increases in July and August. The won-dollar exchange rate hit 1,559.20 won on the 1st, the highest level since the global financial crisis, before retreating to around 1,520 won amid expectations of approximately $30 billion in inflows from SK Hynix's ADR listing. Market participants view the yield range dynamics as tied to the hawkish tone of Bank of Korea Governor Shin Hyun-song's communication and the probability assessment of back-to-back rate hikes.
Market participants state that if consecutive rate hikes occur in July and August, the 4% level could materialize again. Conversely, for the range itself to shift below 3.7%, Governor Shin Hyun-song's hawkish tone would need to soften at this month's Monetary Policy Committee meeting, according to bond dealers.
BOK Reassesses Rate-FX Link Through Australia Case Study
The Bank of Korea's internal perspective on the relationship between exchange rates and interest rates has shifted, according to May Monetary Policy Committee minutes. In response to a committee member's question, the relevant department stated that while exchange rates were previously driven mainly by US dollar movements with limited impact from domestic rate changes, recent cases such as Australia suggest the influence of interest rates on exchange rates may have increased.
The department explained that the Reserve Bank of Australia raised its policy rate three times this year, and while the commodity currency nature of the Australian dollar makes it difficult to precisely identify the effect of rate hikes, the rate increases resolved the real and nominal rate inversion with the United States, leading to Australian dollar strength. The BOK stated it would review the impact of domestic rate hikes on exchange rates by referencing such cases.
This examination goes beyond simply reaffirming the conventional wisdom that 'raising rates helps defend the exchange rate.' It indicates the BOK is officially reviewing the possibility that the traditional link between domestic rates and exchange rates, which had weakened, may be strengthening again in recent periods.
Market Views Back-to-Back Hike Probability as Low Absent Clear Guidance
Market participants do not assign high probability to the realization of back-to-back rate hikes itself. If inflation and growth indicators do not significantly deviate from levels supporting a single July hike, the incentive to raise rates consecutively through August remains limited, according to the majority view.
A bond dealer at Securities Firm A stated that in terms of probability alone, back-to-back hikes represent a low-probability scenario. The issue is not probability but certainty, the dealer noted, explaining that what the market wants is for the BOK to provide a signal close to a commitment not to raise rates in August while implementing a July hike.
Even if a scenario has low probability, if the Governor does not completely close off that possibility, the market has no choice but to continue pricing in that possibility and maintaining tension, according to this logic.
A bond dealer at Securities Firm B stated that the market could gain breathing room if back-to-back hikes are ruled out, but this would require a commitment-level statement from the Governor's remarks. The problem lies in the low likelihood of Governor Shin providing such a commitment. Since taking office, Governor Shin has consistently maintained a hawkish communication stance at press conferences and various other venues.
Given this style, market participants generally assess that it would be burdensome for him to make statements that preemptively rule out the possibility of an August hike. From the BOK's standpoint, there is also a view that there is no need to commit to a specific path in advance. If the BOK promises an August freeze in advance when conditions two months later remain uncertain, and inflation or exchange rate conditions subsequently change, it would be narrowing its own room for maneuver.
Market participants view a unanimous vote for a rate hike accompanied by nuanced signals that an immediate August hike is not planned as the consensus outcome for this Monetary Policy Committee meeting. If such signals are confirmed, the market has room to respond positively. However, separate from the consensus, there remains the possibility that Governor Shin may not provide even this level of clear nuance. In that case, even if the actual probability of back-to-back hikes remains low, the market would continue to carry the tail risk of that low probability.
As a result, the prevailing forecast is that Korean government bonds are highly likely to continue a lackluster trend without finding clear direction within the 3.7-3.9% range. The key to a rebound ultimately depends not on the question of probability, but on how definitively the Governor commits to that probability through his statements.
FAQ
What is keeping Korean 3-year government bond yields in the 3.7-3.9% range?
Bond dealers attribute the range-bound movement to uncertainty regarding consecutive rate hikes in July and August by the Bank of Korea, combined with the hawkish communication style of Governor Shin Hyun-song. Market participants state that the upper bound could extend to 4% if back-to-back hikes materialize, while a shift below 3.7% would require softer hawkish tone from the Governor at the Monetary Policy Committee meeting.
Why did the BOK reference Australia's rate hike experience in May minutes?
According to May Monetary Policy Committee minutes, the BOK's relevant department cited the Reserve Bank of Australia's three rate hikes this year as a case study showing that interest rates' influence on exchange rates may have increased. The department explained that Australia's rate increases resolved the real and nominal rate inversion with the United States, leading to Australian dollar strength, and the BOK stated it would review the impact of domestic rate hikes on exchange rates by referencing such cases.
How likely is a back-to-back rate hike in July and August?
Bond dealers assess the probability of consecutive rate hikes in July and August as low, stating that if inflation and growth indicators do not significantly deviate from levels supporting a single July hike, the incentive for back-to-back increases remains limited. However, market participants note that without a commitment-level statement from Governor Shin ruling out an August hike, the market will continue pricing in that possibility despite its low probability.
