Upward pressure on G-bond yields

Government bond trading activity continued to slow down in January 2022

Government bond trading activity continued to slow down in January 2022 (the last month of 2021 on the Lunar year calendar) as liquidity conditions in the banking system tightened markedly in a high liquidity-demand period. Going into details, in the primary bond market, throughout 14 auction sessions in January (-33.3% MoM), about VND29.5tn of G-bonds were offered (-23.9% MoM).

Long-term bonds accounted for nearly 100% of the total offering, more precisely 98.3%, including 10-year G-bonds (VND12.5tn; 42.4%), 15-year G-bonds (VND9.5tn; 32.2%), 20-year G-bonds (VND2.0tn; 6.8%), and finally 30-year G-bonds (VND5tn; 16.9%). The remaining 1.7% share was from the offering of 7- year G-bonds (VND0.5tn).

Out of nearly VND30tn of G-bond offerings, about VND23.1tn of G-bonds were issued, equivalent to the absorption ratio of 78.2%. Interestingly, there were no medium-term bonds (5-year and 7-year tenors) successfully issued for the second month, and demand for medium-term bonds continued plunging for the fifth month since September last year, when their yield levels hit record lows in the primary market. For long-term bonds, the absorption ratios for 15-year and 20-year bonds fell to several-month lows, while those for other long-term Gbonds (including 10-year and 30-year G-bonds) remained strong.

Long-term yields recorded in the primary market have continued to be strongly stable since 4Q21. In the month, 15-year yields increased just 1 bps, 20-year and 30- year yields fell by 2 bps and 1 bps, respectively, while 10-year yields remained unchanged.

The short-term tension in banking liquidity demand was also pressing in the G-bond market in the second half of the month, with trading activity falling for the second month to the lowest level in four months. Total trading value fell 6.8% MoM to VND153.6tn, owing to lower demand for long-term G-bonds.Trading on long-term bonds accounted for 54.6% of total trading value, while short-term and medium-term G-bonds made up 4.5% and 35.3%, respectively.

In terms of domestic economic conditions, Kis Vietnam saw several factors that could put upward pressure on G-bond yields in the near term.

First, the tightening in banking liquidity, which was supposed to quickly fade in the post-Tet period, was lasting longer than expected. Overnight to 2-week interbank rates are staying around or above the upper level of policy rates (7-day to 14-day repo rates in the OMO market) in early February. Reasons for tightening banking liquidity conditions include: (1) there is data-based evidence that total reserves of bank accounts in SBV (including required and non-required reserves) fell significantly in the post-Tet period, which means a massive amount of VND is yet to return to the banking system; (2) a need for securing liquidity for banks during a period that SBV reviews and allocates credit room for banks for 1Q22.

Second, credit activity continues to accelerate its growth momentum in the early recovery stage, increasing 2.74% YTD in January, which is the fastest growth on record since 2012. In just four months in the reopening phase since October, there has been more than VND800tn of new credit (8.73% of 2020’s outstanding credit) flooding into the real economy. As the graph below illustrates, credit growth is also remarkably outpacing deposit growth for the fourth straight month. This implies two main things: If (1) a credit-deposit mismatch persists, it will tighten banking liquidity over time and put upward pressure on the low-interest-rate environment, including interbank interest rates and government bond yields, deposit and lending rates will react later; and (2) accelerating credit growth indicates that the ongoing economic recovery is gaining momentum in the reopening stage, which discourages demand for safe-haven government bonds.

Third, assuming the economic recovery continues to gain fast momentum like in the early reopening (especially the recovery in the services sector), combined with surging domestic petroleum prices (which hit the highest level in 8 years in early February), future inflation might be a big risk for the low interest-rate environment, including G-bond yields, in the coming year.

Regarding external forces, there is a high possibility that the global interest rate outlook is facing upside risk with faster timing and greater magnitude than market expectations under surging inflation. Just about one month since the U.S. Federal Reserve released its document from the December FOMC meeting, which laid out the Fed’s median projection of three times of 25 bps increases in the fed funds rate, the market participants have been repricing the probability of the 25 bps increases in the fed funds rate to 6 to 7 times by end-2022. Furthermore, the U.S. 10-year yield also climbed to the highest level in more than two years in mid-February, surpassing the pre-pandemic level. A fast ending of the global super-low interest rate environment during the pandemic would also create upward pressure on Vietnam’s interest rate environment, including Vietnam’s G-bond yields.