US 10-year Treasury yield tops 5%, rattling Korean markets and borrowers

The yield on the US 10-year Treasury note has broken through 5 percent, sending a chill through South Korea's financial markets. The surge threatens to accelerate foreign capital outflows from the local stock market and weaken the won, while also pushing up bank bond and corporate bond yields in ways that could raise borrowing costs for households and businesses alike.

Retail investors who took out loans to buy stocks could face a double blow — falling share prices on top of rising interest payments. There are also growing concerns that lower-rated small and medium-sized enterprises and self-employed borrowers could hit a wall of tightening credit, as funding costs climb and lenders raise the bar for new loans.

According to electronic trading platform Tradeweb, the US 10-year Treasury yield surged about 11.6 basis points — one basis point equals 0.01 percentage point — to an annualized 5.083 percent as of 11:56 a.m. Eastern time on Wednesday (local time), the highest level since 2007.

The preliminary reading of S&P Global's September US composite purchasing managers index came in at 58.4, a 62-month high, stoking expectations that the Federal Reserve could raise its benchmark interest rate further. Concerns that strong economic activity, supply chain bottlenecks and labor shortages could reignite inflation also pushed bond yields higher.

The first place the shock from rising US Treasury yields could show up is in South Korea's own stock market. As the appeal of US Treasuries — offering roughly 5 percent annually with no risk — grows, investors are more likely to pull money out of emerging-market equities such as Korean stocks and shift into dollar-denominated assets.

A broader foreign selloff could push the Kospi lower and put upward pressure on the won-dollar exchange rate. Growth stocks — semiconductors, biotech and secondary battery companies, whose share prices heavily reflect expectations of future earnings — are particularly vulnerable to a higher discount rate, since rising interest rates reduce the present value of profits expected further down the road.

With the Kospi already swinging sharply in recent sessions, a sudden spike in US Treasury yields could amplify volatility further. A weaker won may flatter the won-denominated earnings of exporters, but it also drives up the cost of raw materials and energy imports, adding to the burden of domestically focused companies.

Recent Bank of Korea research identified global inflation shocks as the key driver of the synchronization between Korean and US long-term interest rates. The analysis found that US-originated shocks feed through to domestic long-term rates mainly via market expectations that the Bank of Korea will follow with its own rate increases, rather than through a simple flight to safety.

Individual bond investors are not insulated either. When yields rise, the prices of existing bonds fall. Investors holding long-duration bonds or US Treasury exchange-traded funds could see their paper losses widen. For those looking to buy bonds fresh, however, the environment offers the opportunity to lock in higher interest income.

If rising US Treasury yields pull domestic government bond and bank bond yields higher, the effect will eventually feed through to household loan rates as well.

Fixed-rate mortgage loans are primarily benchmarked against the five-year bank bond yield, so market rate increases tend to be reflected relatively quickly in rates on new and refinanced loans. Variable-rate mortgages can also rise through the COFIX index as banks' funding costs increase. Personal credit loans are similarly exposed to short-term market rates, including bank bond yields.

On Wednesday, the yield on the domestic three-year government bond stood at an annualized 4.006 percent, while the yield on three-year AA-rated corporate bonds was 4.689 percent — already elevated even before the full impact of the US rate shock had been priced in.

According to the Bank of Korea, the average interest rate on new loans extended by deposit-taking banks in July was 4.27 percent annually. The central bank has previously noted that a 74-basis-point rise in the five-year bank bond yield was accompanied by a 33-basis-point increase in household loan rates — meaning that even when banks partially offset market rate increases by trimming their lending spreads, the net effect is still upward pressure on borrowing costs.

If loan rates rise by 0.25 percentage point, a borrower carrying a loan balance of 500 million won ($368,000) would face roughly 1.25 million won more in annual interest. A 0.50-percentage-point increase would push the additional annual burden to 2.5 million won. Deposit rates may also edge up, but households whose debts outweigh their financial assets will feel the squeeze far more acutely than any benefit from higher savings yields.

The high-rate shock emanating from the United States could hit small and medium-sized enterprises harder than large conglomerates. Large companies have options — issuing corporate bonds or tapping overseas funding — but smaller firms depend heavily on domestic bank and non-bank lending.

As market rates rise, banks' own funding costs increase. Lenders may respond by raising rates on business loans or tightening credit screening, particularly for lower-rated borrowers. Small and medium-sized enterprises that need to roll over existing loans could face not only higher rates but also reduced credit limits or demands for additional collateral.

According to the Bank of Korea, the outstanding balance of financial-sector loans to small and medium-sized enterprises reached 1,643.7 trillion won at the end of the first quarter of this year. The delinquency rate on SME loans stood at 2.87 percent — roughly 10 times the 0.29 percent rate for large corporations. The overall corporate loan delinquency rate of 2.43 percent also exceeded its long-term average.

The earnings power of small and medium-sized enterprises has not fully recovered either. Bank of Korea analysis found that interest rate movements — whether rates are rising or falling — have a significant impact on the interest coverage ratio of smaller firms. Companies with thin operating profit and high debt dependence struggle to service their interest obligations even on modest rate increases.

Sectors already under strain — construction, petrochemicals and metal products — face a particular risk of rising corporate bond issuance costs and difficulty refinancing maturing debt. Even export-oriented small and medium-sized enterprises may find that higher raw material import costs and foreign-currency loan repayment burdens from a weaker won outweigh any sales boost from currency depreciation.

The Bank of Korea's own rate calculus has grown more complicated. The central bank has already raised its benchmark interest rate twice consecutively, from 2.50 percent to 3.00 percent, and projects that inflation will remain above its target for a considerable period.

Domestic economic conditions and the strain on vulnerable borrowers would argue for slowing the pace of rate increases, but the central bank can ill afford to ignore a widening interest rate gap with the United States, a weakening won and rising import prices. If US high rates persist, expectations of further Bank of Korea tightening could build, setting off a cycle in which government bond yields, bank bond yields and loan rates all climb again.

Ultimately, the shock that ordinary Koreans feel is likely to arrive simultaneously through share prices, the exchange rate and loan interest payments. Whether the rise in US long-term yields proves temporary or leads to further Federal Reserve tightening will be the defining variable for the financial burden facing Korean households and businesses.