Government Bond Yield

Picture lending money to the most creditworthy friend you have. There is almost no risk of losing it, so a little interest is enough for you to lend with peace of mind. When a government runs short of money for building roads or running welfare programs, it writes a certificate (a government bond) that says 'we will pay back this much by this date' and borrows the money. The return the government promises here is the government bond yield, the price of the safest money there is.

The government bond yield is the starting point from which many other market rates move. In Korea, bank loan rates are usually set by taking a benchmark such as COFIX (an index of banks' funding costs) or the yield on bank bonds and adding a spread. Those benchmarks also tend to move together with government bond yields. Ordinary companies and individuals are riskier than the government, so of course they have to pay more interest than the government does.

That is why, when government bond yields rise, mortgage rates and deposit rates often rise too. When government bond yields fall, the burden of loan interest gets lighter and money flows more easily through the market.

To put it more precisely, a government bond yield moves up and down every moment with the price at which the bond trades in the market. The amount paid at maturity and the coupon (the promised amount printed on the bond at the start) are fixed. Say a bond that pays back 1,000,000 won at maturity loses popularity, and you can now buy it for 900,000 won. Your return (yield) until maturity jumps.

So bond prices and yields are like a seesaw, moving in opposite directions. When more people want to buy bonds and the price goes up, the yield you can collect goes down. When the economy looks shaky, or people expect rates to climb further and dump their bonds, bond prices fall and yields shoot up.

When the news says a government bond yield 'surged,' it does not mean newly issued bonds now pay more interest. It means the price of bonds that were already issued and are trading in the market has dropped, so the real return for investors has gone up.

The government bond yield is the first mirror economists look into when they try to predict the future. If the economy is about to pick up and prices are expected to rise, people demand more interest, so long-term bond yields climb. They want to be paid back for inflation (rising prices), which makes money worth less.

On the other hand, when a downturn looks likely, money rushes into safe government bonds. When everyone lines up to buy them, bond prices rise and bond yields drop sharply. That is why a long run of falling long-term yields is often read as a sign that market players see a gloomy economy ahead.

Sometimes something odd even happens: the yield on a long 10-year bond falls below the yield on a short 2-year bond. This shows up when the market expects the economy to weaken and rates to come down, so it is often read as a warning light for a recession. But this signal is not always right.