Credit rally rides KTB dip but stumbles on surging short-term rates

The credit spread tightening seen in the corporate and bank bond markets earlier this month is nothing more than a temporary technical illusion, analysts said. It is not a real improvement in funding conditions but a belated reaction to the fall in Korea Treasury Bond (KTB) yields, and the rally is expected to fizzle out soon as short-term money market rates climb steeply and institutional investors close their books for the year.

Kim Eun-gi, an analyst at Samsung Securities, strongly questioned the sustainability of the ongoing credit spread narrowing in a market report released on Nov. 7. The fourth quarter is typically a weak season for credit, when institutional investors begin book closing early and fund redemption demand surges, causing credit spreads to widen sharply, especially for lower-rated bonds. But in the first week of this month, contrary to market expectations, the yield gap with KTBs narrowed, led by high-grade bonds.

As of Nov. 5, the credit spread on three-year AAA-rated bank bonds had narrowed by 1.2 bp from its previous peak in October. Over the same period, spreads on AA- and A+ rated capital company bonds narrowed by 1.1 bp, public corporation bonds by 0.9 bp, and AA- rated corporate bonds by 0.7 bp. Bank bonds and credit finance company bonds, which had been hit by oversupply and a sharp rise in yields, showed the steepest narrowing.

Experts say it is hard to interpret the rebound as a normalization of fundamentals. Outstanding issuance of bank bonds and special bonds remained high this month as well as last month, keeping supply pressure intact. The main reason spreads on bank bonds and credit finance company bonds narrowed was short-term price attractiveness. As KTB yields plunged first on safe-haven demand amid the stock market correction and massive net buying of government bond futures by foreigners, credit yields belatedly followed, temporarily narrowing the yield gap on paper.

The illusion was amplified by inflows into bond funds early in the fourth quarter, riding on the KTB rally, which created short-term buying capacity. Short-term money chasing bond valuation gains rushed in, but it is liquidity that can flow out as soon as the rate direction changes.

The real flashpoint for market anxiety is the steep rise in short-term financial market rates. While long-term KTBs rallied, the 91-day certificate of deposit (CD) rate and 91-day commercial paper (CP) rate, which gauge actual funding costs for companies and financial institutions, have been hitting new highs day after day. If short-term refinancing rates keep rising, institutions holding credit bonds will face negative margins as their funding costs exceed returns. This is a structure in which short-term money market tightening inevitably spills over into the long-term credit market with a lag.

Going forward, credit market volatility is expected to hinge largely on the Bank of Korea Monetary Policy Board's base rate decision and whether it maintains its tightening stance. If KTB yields rebound while the possibility of a rate hike remains, the credit market, which is propped up by a thin bid base, could quickly turn to heavy selling. In addition, the year-end book closing by institutional investors, which gets into full swing after mid-November, is expected to be a decisive hurdle that forces illiquid corporate bonds and credit finance company bonds to be dumped into the market sequentially.

※ This article is an AI translation of the Korean original published by Korea Credit News; it was checked by automated quality guards and published by the English edition desk.