Credit Spreads Swing on Treasury Yield Volatility; Further Year-End Widening Seen Limited

Credit spreads, which had narrowed to their lowest level in four years, are being rattled as Korea Treasury Bond yields have fluctuated above and below 3% this month. However, market observers expect bond market demand to remain stable, given plans for the launch of the first Integrated Managed Account (IMA) product and expansion of brokerage note businesses before year-end.

The spread between 3-year Korea Treasury Bonds and 3-year AA- rated corporate bonds stood at 47.4 basis points as of the previous day, according to the Korea Financial Investment Association on Monday. The spread had narrowed to the 30 basis point range for the first time in about four years last month, driven by strong corporate bond demand. However, it has widened again amid increased uncertainty from the bond market's year-end off-season and the Bank of Korea's fourth consecutive rate hold. Treasury yields jumping to the 3% range for the first time in two years this month have also stimulated broader market rates.

The prevailing view is that spreads are likely to continue widening as year-end seasonality is being priced in. Analysts note that temporary spread widening is inevitable due to the issuance of new 3-year Treasury bonds this month and the resulting change in benchmark bonds. Treasury yields have temporarily declined, while corporate bond yields have risen from the 3.3% range last month to the 3.5% range due to reduced demand and lower trading volumes.

"Credit spreads have widened as Treasury yields fell, led by benchmark bonds, following new issuances and benchmark changes," said Kim Eun-gi, a researcher at Samsung Securities. "Long-term Treasury yields have risen sharply recently, bringing 10-year Treasury yields close to corporate bond yields, and corporate bond demand is weak due to the year-end off-season."

Industry consensus holds that further upside from current levels will be limited through year-end. Market concerns have already been priced into rates, and the spread between specialized credit finance bonds and corporate bonds has begun narrowing again due to strength in the former. Additionally, the launch of IMA and brokerage note products by new market entrants before year-end is expected to drive additional demand into the credit bond market.