All Eyes on Fed: BOK 50bp Hike in Oct. Looks Inevitable
The author is an analyst of NH Investment & Securities. He can be reached at sw.kang@nhqv.com. -- Ed.
In September, the FOMC suggested a terminal rate of 4.50~4.75%, mentioning the possibility of a recession in 2Q23. However, the market still doubts the effectiveness of inflation control. US 10yr TB yield is to fluctuate at the current levels for now while the market awaits confirmation of policy effectiveness.
Distrust of Fed, even amid rate hikes in recession
- In September, the FOMC officially admitted the possibility of economic slowdown while hiking the base rate even amid the current slump—a path that is unlikely to be without cost. Elsewhere, even countries with relatively weaker economic momentum are being forced to enact monetary tightening despite recession. Last week, the UK announced a 50bp rate hike and active QT of about GBP10bn per quarter. Tightening outside the US further strengthens US tightening concerns, in turn reinforcing the spiral nature of global interest rates.
- Global tightening cooperation forced by the US and rising risks of global recession will inevitably reduce inflationary pressure over time. Of concern, however, the Fed appears unsure of its policy effectiveness, and the US TB market remains skeptical of the Fed. Since the September FOMC, BEI 10yr-2yr spread reversal has been resolved, and term structure has normalized. Looking at expected mid-term inflation, however, we note that the 5yr5yr swap rate remains at 2.5%. In other words, the market is still questioning whether enough is being done.
- Some time will be needed for the market to digest the latest developments and check the effectiveness of policy. In the meantime, a global TB market price level is to be set based on the terminal rate of the dot plot. Converging on the 2024 year-end FF rate forecast, 10yr TB yield is to remain in the 3.50~3.75% range for now. However, overshooting is a possibility given the chances of a higher terminal rate.
All eyes on Fed: BOK 50bp hike in October looks inevitable
- The BOK governor’s comment that the BOK is not independent of the Fed highlights that the Fed’s rate hike path is important in determining Korea’s hike cycle. Shortly after the September FOMC, Governor Lee Chang-yong mentioned that ‘major assumptions have changed’, suggesting that the MPC’s internal FF rate forecast has been upwardly revised. We interpret this as suggesting that an increase in Korea’s base rate trajectory is also on tap.
- Believing that a 50bp hike is inevitable at the October MPC, we raise our year-end base rate projection to 3.25%. Although the possible controlling of inflation in 4Q22 remains as a key variable, for the time being, the market is to take an additional hike in 1Q23 as given. With yields having soared immediately after the September FOMC, the market has already priced in a Korean terminal rate of 3.75%. While additional yield rise is likely to be limited at the current levels, factors with the potential to draw in additional market participants are scarce. We anticipate limited fluctuations until the results of inflation control are confirmed.