An Upturn in Real Interest Rate
The author is a fixed income strategist of Shinhan Investment Corp. He can be reached at jk.ahn@shinhan.com. -- Ed.
US Fed’s strong commitment to monetary tightening leads to an upturn in real interest rate and decline in inflation expectations
We warned investors in our previous reports that it would be risky to fight a central bank firmly committed to reining in inflation. Yields on 10Y and 2Y US Treasuries actually rose by 41bp and 48bp, respectively, on confirmation of the US Fed’s strong commitment to monetary tightening at the Jackson Hole meeting. The August jobs data and consumer price index both provided support for the Fed’s tightening stance. The 10Y US Treasury yield increased to post-April 2011 highs in the 3.4% range, and the 2Y US Treasury yield jumped to post-October 2007 highs in the 3.8% range.
The real interest rate in the US rose above 1% following the Jackson Hole meeting, after falling in previous months despite a combined rate hike of 150bp at the two FOMC meetings in June and July. Before the meeting, the market had been doubting that the US Fed would be able to raise rates further with the base rate fast approaching the neutral level of 2.5%. In addition, recession fears continued to rise with the country's GDP falling for a second consecutive quarter. Market participants had expected the Fed, after completing a combined rate hike of 150bp, to take on a dovish stance with the base rate nearing the neutral level and the economy shrinking for a second quarter.
However, back-to-back 75bp rate hikes hardly made an impact amid the decline in real interest rate and subsequent rebound in inflation expectations. Rising concerns over prolonged inflation prompted the US Fed to strengthen its monetary tightening efforts from August and reiterate its clear commitment to fighting inflation at the Jackson Hole meeting. As a result, the real interest rate is nearing the 1.10% levels last recorded in November 2018, showing that the financial market is now responding normally to the US Fed’s tightening measures unlike in June and July. With all eyes on the September FOMC meeting, this week we expect to see limited movement at a yield band of 3.68-3.82% for 3Y KTBs and 3.68-3.84% for 10Y KTBs (3Y-10Y yield spread 2-5bp).