MERS spending expected to boost bond yields

Korea’s bond market is bracing for a jump in yields as the government plans new spending to protect the economy from a deadly virus that’s damping confidence.

Issuance to fund the stimulus will add to a planned increase in sovereign sales and record supply of mortgage-backed debt.

That will push the benchmark 10-year yield to 2.60 percent this month, a level last seen in January, according to the median estimate of six primary dealers and two brokerages surveyed by Bloomberg from June 18 to June 19.

The yield rose seven basis points this week to 2.51 percent as of 12:56 p.m. in Seoul after Finance Minister Choi Kyung-hwan said Monday an extra budget is needed because Middle East respiratory syndrome (MERS) is having a “significant” impact on the economy amid weak exports and domestic demand.

Australia and New Zealand Banking Group estimates spending of as much as 25 trillion won ($22.6 billion) to be unveiled as early as this week, double a 2014 package announced after the Sewol ferry disaster.

“Now that the market is pricing in the extra budget, it’s difficult for policy makers not to do something,” said Raymond Yeung, a Hong Kong-based economist at ANZ. “It appears difficult to attain a 3 percent growth rate this year without a stimulus package.”

Choi said June 15 he expects the economy to grow around 3 percent this year, less that the official forecast of 3.8 percent.

The government will review its projection when it announces policies for the second half by the month-end. Goldman Sachs Group on June 9 lowered its 2015 forecast to 2.8 percent from 3.3 percent, citing weak exports and MERS.

ANZ expects the outbreak to shave around 0.4 percentage point from this year’s growth, while Nomura Holdings estimates a 0.3 percentage point hit and projects an extra budget of at least 10 trillion won. The median estimate in the Bloomberg survey was for a 20 trillion won package, or 1.4 percent of last year’s gross domestic product.

End-June predictions for the 10-year yield ranged from 2.40 percent to 2.70 percent, depending on the size of the additional spending and bond issuance. That compares with a 2.40 percent median estimate in a separate monthly survey from June 12 to June 17 and 2.33 percent in a similar poll in May.

Dongbu Securities estimates monthly sovereign bond sales could increase by 19 percent to 37 percent in the second half from the first. The additional spending could range from 10 trillion to 20 trillion won and boost growth by as much as 0.9 percentage point, said Moon Hong-cheol, a fixed-income strategist at the primary dealer.

A smaller-than-expected package would disappoint investors and revive calls for the Bank of Korea to cut rates again, sending yields lower, according to Samsung Securities, another primary dealer.

The 10-year yield has risen 20 basis points this month following a 12 basis point drop in May.

“An extra budget of around 10 trillion won will address the impact from MERS alone, and monetary policy will be the only measure left to support growth,” said Shin Hong-sup, a strategist at the firm in Seoul. “But a decision to spend more than 15 trillion won will send the long-term yield higher.”

The BOK cut borrowing costs to a record 1.5 percent this month and Gov. Lee Ju-yeol called MERS an “imminent threat” to consumption. The virus killed 27 people, put over 6,000 in quarantine and caused more than 120,000 travelers to cancel trips to Korea since June 1, official estimates show.

The Finance Ministry said in December it plans to increase sovereign-debt sales by 5.3 percent to 102.7 trillion won in 2015. State-backed Korea Housing Finance plans to offer 53.9 trillion won of bonds backed by home loans this year, more than triple the 14.5 trillion won sold in 2014.

“It remains to be seen who will absorb the additional bond supply,” said Lhee Jung-bum, a fixed-income analyst at Korea Investment and Securities. “While demand for long-term bonds by investors such as pension funds and insurance companies has been high, the MBS issuance and expected extra budget is something new.”

Bloomberg