With the UK voting to leave the EU, uncertainties are predicted to extend for the time being. As such, we believe that the global monetary easing trend will strengthen. Under the worst-case scenario, the Fed may even consider cutting the FF rate. Considering that the possibility of an additional domestic rate cut has heightened further, we suggest expanding duration of KTBs upon yield rises.

▶Global bond market outlook

Developed markets: As the UK has voted to leave the EU, we believe that it will be difficult for the Fed to raise the Federal Funds (FF) rate this year. Moreover, under the worst-case scenario, the Fed may even consider cutting the FF rate. As such, the US TB-Bund spread and US 2/10yr TB spread will likely narrow and the EMU spread should expand.
Asia (excluding Japan): Sentiment towards EM bonds will likely experience a temporary shock owing to Brexit concerns. However, we believe that EM bond markets will then strengthen on expanding global monetary easing.


▶Domestic bond market outlook

Amid the UK’s decision to leave the EU, global investors are panicking, displaying a flight to safety. Recognized as a safe asset, KTBs strengthened notably. Considering the fears over a global economic slowdown and the risk of an EU collapse (due to Brexit), we believe that uncertainties will extend for the time being. At this juncture, we recommend focusing on: 1) the outcome of Spain’s general election; 2) calls for independence in Scotland and Northern Ireland; and 3) calls for referendums to leave the EU in France and the Netherlands.
The key point will be how closely the UK and EU cooperate to minimize the Brexit shock while restructuring their relationship. Although EU members will conduct discussions through various channels, it will likely prove difficult to find an ideal solution due to conflicts of interests and the strengthening conservative stance in some EU nations. As such, we believe that global economic and political uncertainties will sustain for now, strengthening the monetary easing trend. Under the worst-case scenario, the Fed might even consider cutting the FF rate.
Against this backdrop, we forecast that the bond market will strengthen slightly, with 3yr KTB yield ranging 1.20~1.28%, 5yr KTB yield moving 1.25~1.34%, and 10yr KTB yield moving 1.45~1.53%. Despite the price burden, we note that the possibility of an additional domestic rate cut has heightened due to extending external uncertainties and strengthening monetary easing. We believe that in the current age of uncertainty, government bonds will become more valuable. As such, we suggest expanding duration on KTBs upon yield rises.

▶Trading recommendations

We advise: 1) remaining long on 10yr KTBis; 2) remaining long on 10yr KTB; 3) remaining long on 5yr Indonesian bonds; 4) maintaining a US 2/10yr TB flattener position; and 5) remaining long on 5yr Thai bonds.

Source: NH Investment & Securities