South Korean credit market participants are observing buying activity in 1- to 2-year bonds despite credit spreads reaching record highs, raising expectations that the market may stabilize in the near term. The Bank of Korea is widely expected to begin raising its base rate this month with a potentially hawkish stance, but market sentiment reflects growing belief that the current tightening cycle may be limited to four rate increases. This cautious optimism has been reinforced by the dollar-won exchange rate retreating from near 1,560 won to around 1,500 won and increased volatility in the KOSPI index, which hit 9,000 mid-last month before correcting in July.
Short-Term Bond Buying Emerges Amid Record Spreads
Bond dealers reported that 1-year special bank bonds were issued below the market average rate (민평) and 1.5-year special bank bond offerings closed quickly. A bond dealer at a securities firm stated that these developments are providing stability to the short-term market, with participants adopting a mindset that they can withstand up to four rate hikes based on 1-year bond positioning. The 1-year special bank bond 민평 rate stood at 3.711% on the 10th, approximately 20 basis points above the 3.5% level that would result from four 25-basis-point rate increases.
BOK Rate Hike Expectations and Market Positioning
Market participants expect the Bank of Korea Monetary Policy Committee to begin raising the base rate this month. Concerns about a big step (50-basis-point hike) or back-to-back increases in July and August have diminished significantly. The dollar-won exchange rate's decline from near 1,560 won to around 1,500 won has been identified as a major contributing factor to this shift in expectations. The KOSPI's correction in July after reaching 9,000 mid-last month has also contributed to some safe-asset preference among investors.
Fund Inflows Support Credit Market
According to the Korea Financial Investment Association, money market fund (MMF) principal stood 20.0841 trillion won higher than the end of the previous month as of the 9th. Excluding approximately 5 trillion won in outflows on the 9th alone, MMFs recorded net inflows for six consecutive trading days. Bond funds received net inflows of 3.2 trillion won during the same period, reversing the 5 trillion won in net outflows from the previous month. Market participants view these early-half inflows as a positive factor following the successful navigation of the half-year end.
Dealer Sentiment Shifts from Negative to Neutral
A bond dealer at a securities firm stated that credit demand has increased noticeably, though preferences remain highly selective with significant temperature differences across maturity segments and sectors. The dealer characterized the shift as moving from negative buying sentiment to neutral, describing the current period as one where participants can earn carry (interest income) while buying time. Another dealer explained that while the buying sentiment may not strengthen if rate hike forecasts become more hawkish than current expectations, the confirmation of recent factors suggests that market participants had been overly cautious.
Near-Term Variables Identified by Market Participants
Market participants stated on the 13th that the credit market's momentum will depend on the hawkish intensity of Bank of Korea Governor Shin Hyun-song's remarks at this month's Monetary Policy Committee meeting and the results of the public bond issuer consultative body meeting at the end of this month. Park Moon-hyun, Chief Credit Bond Researcher at KB Securities, noted that repo fund maturities this year will not be re-executed due to uncertainty about how much funding costs will rise as the base rate increases. Park also pointed out that while MMF funds have recovered at the start of the quarter, historical patterns show MMF outflows when the base rate is actually raised. He identified the concentration of commercial paper and electronic short-term bond maturities at securities firms ahead of this month's Monetary Policy Committee meeting as a potential volatility factor. Park stated that positive developments could emerge from the third-quarter public bond issuer consultative body meeting, noting that bank bond and special bond issuance has increased significantly compared to the first quarter and long-term bond supply appears depleted, suggesting that comments reducing market burden related to issuance could benefit the credit market.
FAQ
What is happening in South Korea's credit market despite record spreads?
Buying activity is emerging in 1- to 2-year bonds, with 1-year special bank bonds issued below the market average rate and 1.5-year offerings closing quickly, raising expectations of near-term market stabilization.
How much have fund flows into Korean bond markets increased?
Money market funds recorded net inflows totaling 20.0841 trillion won versus the end of the previous month as of the 9th (excluding a 5 trillion won outflow on the 9th alone), while bond funds received 3.2 trillion won in net inflows during the same period.
What factors are market participants monitoring for the credit market outlook?
Participants are focused on the hawkish intensity of Bank of Korea Governor Shin Hyun-song's remarks at this month's Monetary Policy Committee meeting and the results of the public bond issuer consultative body meeting at the end of this month.
